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ECONOMICS 

IN TWO VOLUMES 



Volume II 
MODERN ECONOMIC PROBLEMS 



/ 

Economtcs— iDolume ii 

MODERN 
ECONOMIC PROBLEMS 

SECOND EDITION, REVISED 



BY 



FRANK A. FETTER, PH.D., LL.D. 

PROFESSOR OP POLITICAL ECONOMY, PRINCETON UNIVERSITY 




NEW YORK 
THE CENTURY CO. 
1922 



CLfr-^ 



iW <-'-' 



^ 









Copyright, 1916, 1922, by 
The Centuby Co. 1/ 



First Edition, 1916 
Reprinted January, 1917 
December, 1918 
September, 1919 
February, 1920 
March, 1920 
February, 1921 
Revised Edition, 1922 



PRINTED IN U. S. A. 



A. 



FEB 1 5 1922 / 



TO 

THE MOTHER 

WITH A YOUTHFUL HEART AND 
SYMPATHETIC INTEREST 
IN ALL THINGS HUMAN 



TABLE OF CONTENTS 

PAGE 

Part I. Money and Prices <• 

1. Nature of economics problems 3 

2. Origin and nature of money 11 

3. Commodity money and the quantity theory 25 

4. Fiduciary money, metal and paper 30 

5. Price levels and the gold standard 54 

6. Rising prices and the standard 70 

Part II. Banking and Insurance 

7. The functions of banks 91 

8. Banking in the United States before 1914 107 

9. ThQ Federal Reserve Act 117 

10. Crises and industrial depressions 138 

11. Institutions for saving and investment . . . . 158 

12. Principles of insurance 176 

13. Scientific life insurance 191 

Part III. Tariff and Taxation 

14. American tariff history 207 

15. International trade 230 

16. The policy of a protective tariff 246 

17. Objects and principles of taxation 270 

18. Property and corporation taxes 288 

19. Personal taxes 304 

Part IV. Wages and Labor 

20. Methods of industrial remuneration 321 

21. Organized labor 337 

22. Public regulation of hours and wages 358 

23. Other protective labor and social legislation .... 379 

24. Social insurance 398 

25. Population and immigration 417 

Part V. Public Policy Toward Private Industry 

26. Agricultural and rural population 441 

27. Problems of agricultural economics , - 457 



TABLE OF CONTENTS 

PAGE 

28. The transportation problem . 477 

29. Railroad regulation 490 

30. The problem of industrial monoply 505 

31. Public policy in respect to monopoly 522 

Pabt VI. Peivate Property versus Socialism 

32. The\ present economic system 543 

33. Public ownership 558 

34. Methods of distribution 574 

35. Socialism, present and future 588 

Index 605 



FOREWORD TO THE REVISED EDITION. 

In this revised edition every chapter has been rewritten 
with reference to the momentons events that have filled the 
years since 1916, when the first edition of this work appeared. 
The statements of facts and figures have so far as possible 
been brought down to date. The materials formerly con- 
stituting the first two chapters have been distributed under 
other headings. New sections appear in every chapter, and 
new chapters have been added in the treatment of money, 
insurance, transportation, and socialism. Numerous charts 
have been added which, it is hoped, will be helpful to the 
reader. Most of these have been reproduced from charts 
prepared for the use of the author's classes, and others have 
been taken from various sources. A brief list of references 
has been appended to each chapter. 

The year 1921, in the depths of an industrial depression, 
does not mark the end of an era of normal economic changes 
in anything like the sense that did the year 1916. Rather it 
might be said that it is the half-way stage in another decade. 
After five years more the broader economic eifects of the 
world war can be much better appraised. It is the author's 
hope, however, that in its present form this volume will aid, 
in some measure, the earnest and open-minded reader to in- 
terpret the important changes now in progress. 

The author makes renewed acknowledgment to those col- 
leagues and other friends who assisted him in various ways 
in the preparation of the first edition. Thanks are due to 
the statistical officers of the Federal Reserve Bank of the 
Second District for permission to reprint diagrams that have 
appeared in the MonthUj Review, and to others named specifi- 
cally in notes to the charts and maps. 

Princeton, N. J., Jan. 2, 1922. 



MODERN 
ECONOMIC PROBLEMS 

PART I 
MONEY AND PRICES 



MODERN 
ECONOMIC PROBLEMS 

CHAPTER 1 
NATURE OF ECONOMIC PROBLEMS 

§ 1. Increase of economic problems. § 2. Opinions and feelings in 
economic discussion. § 3. False contrast of theory and practice. 
§ 4. Superficial thinking and popular error. § 5. American economic 
problems in the past. § 6. Main factors in economic problems. § 7. 
Range of economic problems treated. 

§ 1. Increase of economic problems. The present volume 
deals with various specific problems in economics, as an earlier 
volume deals with the general economic principles of value 
and distribution. The word "problem" is often on our 
tongues. Life itself is and always has been a problem. In 
every time and place in the world there have been questions 
of industrial policy that challenged men for an answer, and 
new and puzzling social problems that called for a solution. 
And yet, when institutions, beliefs, and industrial processes 
were changing slowly from one generation to another and 
men's lives were ruled by tradition, authority, and custom, 
few problems of social organization forced themselves upon 
attention, and the immediate struggle for existence absorbed 
the energies and the interests of men. But the present time 
of rapid change seems to be peculiarly the age of problems. 
The movement of the world has been more rapid in the last 
century than ever before — in population, in natural science, 
in invention, in the changes of political and economic institu- 

3 



4 MONEY AND PRICES [Pt. I 

tioiis ; ill intellectual, religious, moral and social opinions and 
beliefs. 

Some human problems are for the individual to solve, as 
whether it is better to go to school or to go to work, to choose 
this occupation or that, to emigrate or to stay at home. Other 
problems of wider bearing concern the whole family group; 
others, still wider, concern the local community, the state, or 
the nation. In each of these there are more or less mingled 
economic, political, and ethical aspects. Economies in the 
broad sense includes the problems of individual economy, 
domestic economy, of corporate economy, and of national 
economy. In this volume, however, we are to approach the 
subject from the public point of view, to consider primarily 
the problems of ' ' political economy, ' ' considering the private, 
domestic, and corporate problems only insomuch as they are 
connected with those of the nation or of the community as a 
whole. Our field comprises the problems of national wealth 
and of communal welfare. 

§ 2. Opinions and feelings in economic discussion. The 
student beginning economics, or the general reader, is likely 
to think that the study of principles is more difficult than is 
that of concrete questions. In fact, the difficulty of the latter, 
though less obvious, is equally great. The study of princi- 
ples makes demands upon thought that are open and unmis- 
takable ; its conclusions, drawn in the cold light of reason, are 
uncolored by feeling, and are acceptable of all men as long as 
the precise application that may justly be made of them is not 
foreseen. But conclusions regarding practical questions of 
public policy, though they may appear to be simple, usually 
are biased and complicated by assumptions, prejudices, selfish 
interests, and feelings, deep-rooted and often unsuspected. 
When the casual reader declares that he finds the study of 
practical questions in economics much easier than that of 
theory, he really means that the one seems to require little or 
no thought, while the other requires much. 

In many questions feeling is nine tenths of reason, and one's 



Ch. 1] NATURE OF ECONOMIC PROBLEMS 5 

sympathies often dictate one's conclusions. In the following 
pages the reader is repeatedly warned when the discussion 
reaches such a danger point. When, however, in this work, 
outlooks and sympathies are expressed or tacitly assumed, 
they are not so much those personal to the author as they are 
those of our present-day American democratic society, taken 
at about its center of gravity. When the people generally 
feel different as to the ends to be attained, a different public 
policy must be formulated, though the logical analysis of the 
problems may not need to be greatly changed. 

§ 3. False contrast of theory and practice. Still another 
word of caution should be given to those who find theoretical 
economic questions hard but who imagine that the under- 
standing of "practical" economic questions is comparatively 
easy. The very contrasting of theoretical and practical study 
in this way is erroneous and misleading. The true under- 
standing of every so-called "practical" question requires the 
understanding of theory, both the general theory (treated in 
Volume I) that underlies all economic activity, and the 
special theories that are related to the particular problems 
(treated in this volume). Indeed, theory as it is here used, 
and as it ought to be used, is hardly more than a synonym for 
* ' understanding " ; it is logical analysis, insight, orderly ar- 
rangement, in our thought, of the forces, motives, and mate- 
rial conditions that help to bring about certain results. The 
more clearly the student has thought through the general 
theories of value, price, time-preference, wages, etc., the better 
prepared he is to take up the study of such practical problems 
as money, banking, tariff, labor and capital, etc., every one of 
which involves more special theories of price levels, fiat money, 
international trade, the open shop, and minimum wage, re- 
spectively. 

§ 4. Superficial thinking and popular error. A practical 
economic problem is alwaj's presented as a question: What 
is the right thing to do or the best course to pursue with re- 
spect to some matter that is tied up with many other matters ; 



6 MONEY AND PRICES [Pt. I 

SO that the whole situation is usually very complex. The 
first answer of the untrained mind is almost certain to be a 
wrong one—just as to the natural man the earth seems flat, 
though it is round, the sun seems to circle around us, whereas 
we revolve on the earth's axis daily, and at the same time 
slowly circle around the sun ; the echo seems to be a mocking 
spirit answering us, whereas it is our own voice reflected back. 
Thousands of erroneous ideas were held by primitive man, 
and still are held by the savage, the child, and the untrained 
adult mind, regarding the simplest affairs of every-day life. 
In a like manner, the first answers to economic problems are 
usually superficial. 

Since almost every economic matter affects various interests, 
there is the additional difficulty that some groups of persons, 
often influential and powerful, have something to gain by 
continuing to think superficially and by getting those who 
would benefit by the truth to keep on thinking superficially. 
Indeed, to think clearly, even if one suspects that it would be 
to his advantage to do so, is even for the ablest minds a dif- 
ficult task, and for the mass of men, under the conditions, is 
often impossible. It should not surprise us, therefore, to find 
that nearly all economic improvements have been opposed not 
only by the few who would lose but by the many who would 
gain by the change; and to find, likewise, that the projects of 
reform that most quickly win the belief and support of the 
mass of men seeking relief from hard conditions have usually 
been as superficial and false in their theory as the ert'ors they 
were meant to displace. Truth, when at last found, is simpler 
than error, but often it is to be attained only by the hard 
road of analytic and abstract thought that follows through to 
the end the workings of each separate force and factor. 

§ 5. American economic problems in the past. What, 
then, are the politico-economic problems in America? They 
are problems that are economic in nature because they concern 
the way that wealth shall be used and that citizens are enabled 
to make a living, but that are likewise political because they 



Ch. 1] NATURE OF ECONOMIC PROBLEMS 7 

can be solved only collectively by political action. With the 
first settlements of colonists on this continent politico-eco- 
nomic problems appeared. Take, for example, the land 
policy. Each group of colonists and each proprietary land- 
holder had to adopt some method of land tenure, whether by 
free grant or by sale of separate holdings or by leasing to 
settlers. In one way and another these questions were an- 
swered; but rapidly changing conditions soon forced upon 
men the reconsideration of the problem as the old solution 
ceased to be satisfactory. 

In large part our political history is but the reflection of 
the economic motives and economic changes in the national 
life. Thus the American Revolution arose out of resistance 
to England's trade regulations, commercial restrictions, and 
attempted taxation of the colonies. The War of 1812 was 
brought on by interference with American commerce on the 
high seas. The Mexican War was the result of the coloniza- 
tion of Texas territory by American settlers and the desire of 
powerful interests to extend the area of land open to slavery. 
The Civil War arose more immediately out of a difference of 
opinion as to the rights of states to be supreme -in certain 
fields of legislation, but back of this political issue was the 
economic problem of slave labor. Illustrations of this kind, 
which may be. indefinitely multiplied, do not prove that the 
material, economic changes are the cause of all other changes, 
political, scientific, and ethical; for in many cases the eco- 
nomic changes themselves appear to be the results of changes 
of the other kinds. There is a constant action and reaction 
between economic forces and other forces and interests in 
human society, and the needs of economic adjustment are 
constantly changing in nature. 

§ 6. Main factors in economic problems. The particular 
economic problems in America at this time are determined 
by the whole complex economic and social situation. Two 
main factors in this may be distinguished : the objective and 
the subjective, or the material environment and the people 
composing the nation. The one is what we have, the other is 



8 MONEY AND PRICES [Pt. I 

what we are. These factors are closely related : for what We 
are as a people (our tastes, interests, capacities, achievements) 
depends largely on what we have, and what we have (our 
wealth and incomes) depends largely on what we are. 

I. The objective factor presents two phases : 

(a) The basic material resources, consisting of the mate- 
rials of the earth's surface and the natural climatic condi- 
tions which together provide the physical conditions neces- 
sary for human existence, and which furnish the stuff out of 
which men can create new forms of wealth. 

(b) The industrial equipment, consisting of all those arti- 
ficial adaptations and improvements of the original resources 
by which men fit nature better to do their will. These two 
(a and b) become more and more difficult to distinguish in 
settled and civilized communities, and become blended into 
one mass of valuable objects, the wealth of the nation. 

II. The subjective factor presents two phases: 

(a) The people, considered with reference to their num- 
ber, race, intelligence, education, and moral, political, and 
economic capacity. 

(b) The social system under which men live together, 
make use of wealth and of their own services, and exchange 
economic goods. 

The particular economic problems that are presented to 
each generation of people are the resultant of all these factors 
taken together. A change in any one of them alters to some 
extent the nature of the problem. The problems change, for 
example, (la) with the discovery or the exhaustion (or the 
increase or decrease) of any kind of basic material resources; 
(lb) with the multiplication or the improvement of tools and 
machinery or the invention of better industrial equipment; 
(II a) with the increase or decrease of the total number of 
people, and the consequent shift in the relation of popula- 
tion to resources; (II b) with changes in the ideals, educa- 
tion, and capacities of any portion of the people whether or 
not due to changes in the race composition of the population. 



Ch. 1] NATURE OF ECONOMIC PROBLEMS 9 

Many examples of these various changes may be found in 
American history, and some knowledge of them is necessary 
for an appreciation of the genesis and true relation of our 
present-day problems. 

§ 7. Range of economic problems treated. Of number- 
less economic problems that are calling for solution in a 
modern nation like the United States of America, only the 
more important in relation to present needs can be discussed 
in their main aspects within the limits of a single volume. 
The ones here chosen, as may be seen by referring to the table 
of contents, include a wide range, from the more impersonal 
financial questions connected with money and the medium of 
exchange, to the most burning issues of class interests and 
conflicts; and from those that seem to do merely with the 
individual (as incomes or wages or taxes) to the most funda- 
mental questions of the form of economic organization and 
the displacement of private property by communism. In 
truth, these contrasts are often misleading; for the welfare 
of individuals is affected in many ways, often remote and 
unsuspected, on the one hand by impersonal factors such as 
the production of gold or the invention of machinery, and on 
the other hand by the form and function of the social organi- 
zation of which each of us is a part. 

Some conceive of the economist's task narrowly as being 
merely the study of market prices ; others broaden the field to 
include the study of individual valuations and gratifications; 
and still others make it include the solution of all problems 
of economic legislation affecting the general welfare of society. 
No practical problem in the field of economics can be rightly 
solved as if it were an economic problem in any narrow sense 
untouched by political, moral, and social considerations. In 
this volume the broadest of these conceptions is taken, prices 
and values being studied because of their bearing upon social 
welfare. "Welfare economics rather than price economics is 
our ideal. 



10 MONEY AND PRICES [Pt. I 

References: The titles of the chief encyclopedias of economics and of 
several good collections of general readings are given in the Manual 
of references and exercises in economics, for use with the author's 
Economic Principles, published by the Century Co., New York. (Ref- 
erences to the author's Source Book in Economics [1912] have been 
dropped in this edition, as that work is now out of print.) Several 
American general texts on political economy treat more or less fully 
the questions taken up in the present volume. Some of the texts are 
listed here, and are not referred to specifically in connection with 
the various chapters following. 

Carver, T. N., Principles of political economy, 1919. 

Same, Principles of national economy. Boston. Ginn & Co. 1921. 

Fisher, Irving, Elementary principles of economics. New York. 
Macmillan. 1912. 

Ely, R. T., Outlines of economics. Rev. Ed. New York. Macmillan. 
1908. 

Clay, H. Economics. (American Revision.) New York. Macmillan. 
1918. 

Seager, H. R., Principles of economics. New York. Holt. 1913. 

Seligman, E. R. A., Principles of economics. 3d ed. 

Taussig, F. W., Principles of economics. 2 vols. New York. Mac- 
millan. 1911. 

Turner, J. R., Introduction to economics. New York. Scribners. 
1919. 



CHAPTER 2 
ORIGIN AND NATURE OF MONEY 

§ 1. Origin of money. § 2. Money as a tool. § 3. ]Money defined. 
§ 4. Qualities of the original money-good. § 5. Industrial changes and 
forms of money. § 6. The precious metals as money. § 7. Varying 
extent of the use of money. § 8. Relative importance of money. 
§ 9. Standard-commodity money. § 10. Commodity money without 
coinage. § 11. The money -material in its commodity uses. 

§ 1. Origin of money. Everywhere in the world where 
the beginnings of regular trade have appeared, some one of 
the articles of trade soon has come to be taken by many 
traders who did not expect to keep or use it themselves, but 
to pass it along in another trade.^ This made it money, for 
money is whatever comes to be used as a general price-good. 
The character of a general price-good clearly distinguishes 
money from goods bought and sold by a particular class of 
merchants, such as grain, cattle, etc., to be sold again. It 
is only in so far as a particular good comes to be taken by 
persons not specially dealing in it, taken for the purpose of 
using it as a price-good to get something else which they de- 
sire, that a thing has the character of money. The thing 
called money thus is a durative good passing from hand to 
hand in a community, and completing its use in turn to 
each possessor of it only as he parts with it in exchange for 
something else. 

The use of money is of such social importance that it would 
be impossible for modern industrial society to exist without 
it. The discussion of money touches many interests; it raises 
many questions of a political and of an ethical nature. There 

1 See Vol. 1, pp. 15-16. 50-53, and 26|2-264,for an introductory state- 
ment of the origin and functions of money. 

11 



12 MONEY AND PRICES [Pt. I 

are perhaps more popular errors on this than on any other 
one subject in economics, but the general principles of money 
are as fully understood and as firmly established as are any 
parts of economics. 

§ 2. Money as a tool. Money is often, by a figure of 
speech, called a tool. A tool is a piece of material taken into 
the hand to apply force to other things, to shape them or 
move them. Figuratively, this is what money does : it moves 
things into one's control. A man takes it, not to get enjoy- 
ment out of it directly, but to apply force, to move something, 
and that which he moves is the thing he buys. Money thus 
(as money) is always an indirect agent. Adam Smith aptly 
likened money to the roads and wagons that transport goods, 
thus gratifying desires by putting goods into more convenient 
places. The fundamental use that money serves is to appor- 
tion one's income conveniently as it accrues and as it is spent. 
The use of money increases the value of goods by increasing 
the ease with which trade can take place. Like any tool or 
agent, money is valued for what it does or helps to do. It en- 
hances the value of the goods that it buys and sells by divid- 
ing them into quantities convenient for use and by making 
them available at the right times. 

It has been said that the service performed by money is to 
overcome the difficulty in barter of the double coincidence of 
wants and possessions. For example, a man may possess a 
horse that he is willing to sell, and he wants in place of it not 
just one thing, but a group of things, say a cow, a bag of flour, 
a pair of shoes, and several other small commodities, perhaps 
preferring not to have them all at once, but distributed over 
a period of some days or some weeks. Now, it is not likely 
that these things would exchange at such ratios in the market 
that the horse would just be of equal value to the group of 
other goods. Little less than a miracle would be needed to 
find a man desiring a horse, and who at the same time pos- 
sessed just that group of goods to exchange for it. So, either no 
trade at all could take place, or there must be a series of trades 



Ch. 2] ORIGIN AND NATURE OP MONEY 13 

in which the man takes some of the things he wants (say a 
cow) and other things "to boot," in the hope that later these 
may be traded for the right things. Evidently, when the 
"possession" is one large thing and the "wants" are many 
(or vice versa), the coincidence required is much more than 
double. In the light of the principles of diminishing gratifi- 
cation and of time-preference, it is clear that the amounts in 
which and the times at which goods are available have an 
essential bearing on their values. Money is the most suc- 
cessful device ever discover,ed for distributing the supplies 
of a journey along its course and the goods of daily need 
over a period of time. The use of money as a storehouse of 
value by hoarding it is merely a more extreme case of keeping 
income until a time when it will have a greater value to the 
owner than it has in the present.^ 

§ 3. Money defined. Money may be defined as a material 
means of payment and medium of trade, passing from hand 
to hand and generally accepted as the most usual price-good. 
The definition contains several ideas. Trade means the taking 
and giving of things of value. Money passes from hand to 
hand, is a thing that can be handled and is, or can be, bodily 
transported. The words "generally accepted" imply that 
money has a peculiar social character, is not an ordinary 
good. As a price-good, money itself must be a thing having 
value ; otherwise it could not be accepted. 

The application of the definition is not always easy, for 
money shades off into other things that serve the same purpose 
and are related in nature. Money is not merely an order for 
goods, as a card or paper requesting payment; it is itself a 
thing of value (though this value may be due partly or solely 
to its possessing the money function). Such things as a tele- 
gram when transferring an order for the payment of money, 

2 The old-fashioned miser, however, withdraws his hoarded jrold for 
the time from its usual monetary function as an indirect agent, and 
treats It as a direct good yielding to him psychic income by its mere 
possession. 



14 MONEY AND PRICES [Pt. I 

as the spoken word, and as a mere promise to pay, are not 
money. Even checks and drafts are merely written evidences 
of credit, and are nsed as substitutes for money. 

In many problems money appears to be at the same time 
like and unlike other things of value, and just wherein lies the 
difference it is often difficult to determine. Even special 
students differ as to the border-line of the concept, but as to 
the general nature of money there is essential agreement. 

§4. Qualities of the original money-good. The selection 
of any money-commodity has not been made by chance, but 
has been the result of that object being better fitted than 
others to serve as a medium of exchange. The main quali- 
ties that affected the selection of primitive forms of money 
were as follows : 

1. Marketability (or salability) ; that is, it must be easy to 
sell. The first forms of money had to be things that every 
one desired at some time and many people desired at any time. 
That was the essential quality that made any one ready to 
take it when he did not wish its direct use himself. Many 
kinds of food and of clothing are very generally desired goods. 
But few of these classes of goods have in a high measure 
certain other important qualities, now to be named. 

2. Trans'porta'bility ; that is, the money material must be 
easy to carry; it must have a large value in small bulk and 
weight. To carry a bag of wheat on one's back a few miles 
requires as great an effort ordinarily as does the raising 
of the wheat; and the cost of carriage for fifty miles, even 
by wagon, will often equal the whole value of the wheat. 
Cattle, while not comparatively very valuable in proportion 
to weight, and not possessing the other qualities of money 
in the highest degree, have the advantage that they can be 
made to carry themselves long distances, and therefore they 
have been much used as money in simpler economic condi- 
tions. 

3. Cognizability; that is, the money-good must be easy to 
know, and to judge as to quality. If expert knowledge or 



Ch. 2] ORIGIX AND NATURE OF MONEY 15 

special apparatus is needed to test it in order to avoid counter- 
feits, few could be ready to take it, and trading would be a 
costly process. 

4. Durahility ; that is, the money-good must be easy to 
keep without much loss in amount or in quality, perhaps 
for long periods, until it can be passed on in trade. Few 
kinds of food answer very well to this last requirement, 
bfeing organic and perishable. But all four qualities above 
named were pretty well embodied in primitive times in rock- 
salt, in rare flints and bits of copper suitable for tools and 
weapons, in furs in northern countries, and in many articles 
of personal adornment, such as beads, feathers, jewels, and 
metal ornaments. 

5. Divisibility; that is, the quality in the monetary ma- 
terial that permits it to be divided/' easijly i'nto smaller 
amounts and then to be united again into larger masses at 
little cost and without loss in amount or in quality. This 
quality is present only when the material is homogeneous 
throughout the whole mass, a condition fulfilled more com- 
pletely by the metals than by any other goods. - This quality 
makes it possible to put the governmental stamp upon the 
money material, and to produce pieces some of which are 
exact duplicates and some exact multiples, of others. In this 
manner pieces of money are provided suitable for transac- 
tions of different magnitudes, down to small fractional 
amounts. A monetary system of this kind aids greatly the 
development of the sense and habit of exact estimation of 
price. 

§ 5. Industrial changes and the forms of money. The 
money use, as has just been shown, is a resultant of a number 
of different motives in men. The changing material and in- 
dustrial conditions of society change the kind of money that 
is used. Things that have the highest claim to fitness for 
money with a people at one stage of development have a low 
claim at another. The final choice of the money-good de- 
pends on the resultant of all the advantages. Shells are 



16 MONEY AND PRICES [Pt. I 

used for ornament in poor communities, but cease to be so used 
in a higher state of advancement, and thus their salability 
ceases. Furs cease to be generally marketable in northern 
climes when the fur-bearing animals are nearly killed off 
and the fur trade declines. "When tobacco was the great 
staple of export from Virginia, everybody was willing to 
take it, and its market price was known by all. It served 
well then as the chief money ; but, as it ceased to be the almost 
exclusive product of the province, it lost the knowableness 
and marketability it had before. In agricultural and pas- 
toral communities where every one had a share in the pas- 
ture, cattle were a fairly convenient form of money; but in 
the city trades of to-day their use as money is impossible. 
Thus, in a sense, different commodities compete, each trying 
to prove its fitness to be a medium of trade ; but only one, 
or two, or three at the most, can at one time hold such a 
place. 

While industrial changes and conditions affect the choice of 
money, in turn money reacts upon the other industrial con- 
ditions. If a new and more convenient material is found or 
thje value of the money metal changes to a degree that 
affects the generalness of its use, industry is greatly affected. 
The discovery of mines in America brought into Europe in 
the sixteenth century a great supply of the pr.ecious metals, 
and this change in the use of money reacted powerfully upon 
industry. Money, being itself one of the most important of 
the industrial conditions, is affectied by and in turn affects 
all others. 

§ 6. The precious metals as money. Certain of the met- 
als early began to show their superior fitness to perform the 
monetary function. The metals first used as money were 
copper, bronze (an alloy of copper with nickel), and iron. 
Th^ese were truly precious metals in early times, for they 
were found only in small quantities in a few localities. They, 
therefore, were widely sought and highly valued as orna- 
ments and for use as tools and weapons. But as the great 



Ch. 2] ORIGIN AND NATURE OF MONEY 17 

ancient nations emerged into history, these materials were 
already being displaced in large measure. Their value fell 
greatly as a result of greater production due to somewhat reg- 
ular mining. As wjealth grew, as trade increased, as the use 
of money developed, as commerce extended to more distant 
lands, the heavier, less precious metals failed to serve the 
growmg monetary need, especially in the larger transac- 
tions. Silver and gold, step by step, oft^n making little 
progress in a century, became the staple and dominant forms 
of money in the world, while copper and nickel still con- 
tinued to be used for the smaller monetary pieces. Every 
community has witnessed some stages of this evolution. In 
this contest silver had, up to the end of the Middle Ages, 
proved itself to be, on the whole, the fittest medium of ex- 
change for most purposes, though gold was at the same time 
in use in larger transactions and in international trade among 
the leading commercial countries. 

Gold discoveries in California in 1848, and in Australia, 
two years later, caused the production of gold to increase 
enormously,^ and gold became a relatively larger part of the 
monetary stocks of western European and North American 
countries. 

In a higher degree than any other one material, gold has thje 
qualities of the main monetary material for rich and in- 
dustrially developed communities. England was first to give 
to gold the chief place in its monetary system; the United 
States did so in 1834, and has continued to keep gold in that 
place (except for the period of paper money from 1862 to 
1879) ; France did so about 1879, having shifted gradually 
from silver, aft^er 1855, under the working of the bimetallic 
law; Germany in 1873; and Japan since the later nineties. 
Other countries have been moving in the same direction. 
Since about 1890 some states (including Mexico) and some of 
the colonial possessions of the great nations (including India 
and the Philippines) have adopted the plan of the ''gold-ex- 

8 See chart of gold production, ch 5, Fig. 2. 



18 MONEY AND PRICES [Pt. I 

change standard. ' ' By this plan gold is the standard price unit, 
while silver continues to be used all but exclusively as the 
material in circulation, its amount being controlled and its 
value regulated on principles to be explained below under 
coinage, seigniorage, and foreign exchange. 

The most important of the countries in which silver is still 
the chief form of money is China. There are, however, nu- 
merous countries, notably in South America and Central 
America, in which paper notes have long been almost the 
only form of money ; and in the period of the Great War every 
one of the belligerent countries excepting the United States 
approached or reached that condition where neither gold nor- 
silver was actually in circulation. 

§ 7. Var5dng extent of the use of money. Trade by the 
use of money at no time has become the exclusive method. 
Barter still lingers to-day.^ The extent to which, on an 
average, money is used in diff'erent parts of the world differs 
widely. The use of money in Siberia is less than in Eu- 
ropean Russia, and its use is less there than in western Europe. 
The use of money as compared with barter is generally much 
greater in the cities than in the rural districts. In the cities 
of Mexico not only money but banks and credit agencies are 
in general use; whereas the rural districts are more back- 
ward and make far more use of barter than is the case in the 
United States. At the ports in the cities of China, India, and 
South America the use of money may be very like that in 
European cities ; but go a little way into the interior of these 
countries, and conditions as to the use of money change 
greatly. 

However, the comparative per capita amounts of money 
(in terms of American dollars) in circulation in different 
countries is far from being a true index of their industrial 
development or of their commercial activity. Indeed, beyond 
a certain point the larger average amount of money in cir- 

4 See Vol, I, p. 43, on the decline of barter. 



Ch. 2] OKIGIX AND XATUEE OF MONEY 19 

culation in a country may indicate backwardness in the de- 
velopment of banks and other credit agencies rather than 
greater amount of wealth or of business. Notice, for ex- 
ample, the medium position of the great commercial countries, 
Germany and the United Kingdom, as compared with other 
countries above and below them in the following list. 

Per Capita Circulation of Money in Leading Countries 
december 31, 1912.5 

France $48.91 Norway 12.50 

Australia 38 .45 Sweden 11 . 59 

Canada 33 . 57 Greece 11 . 02 

America (U. S. ) 32 . 98 Mexico 9 . 17 

Portugal 29.46 Finland 8.38 

Netherlands 26.86 Chile 8.24 

Switzerland 24 . 32 Turkey 7 . 09 

Germany 21.36 Russia 6.45 

United Kingdom 21.21 Japan 5 . 68 

Spain 19.96 Bulgaria 5.57 

Brazil 18.79 Serbia 5.49 

Denmark 17.73 Venezuela 5.51 

Belgium 15.83 India (British) 5.19 

Austria-Hungary 14 . 68 Ecuador 4 . 62 

Rumania 13.24 Peru 3. 17 

Italy 13.09 Colombia 2.32 

South Africa 12.93 Paraguay 57 

§ 8. Relative importance of money. Because money is 
the general expression of purchasing power, and comes to 
sjonbolize all other w]ealth, it often assumes undue and ex- 
aggerated importance in men's eyes. Money is but one of 
many forms of wealth. It constitutes but a small percentage 
of the total wealth of a country, and it is far from being the 
most indispensable to human welfare. Yet its importance, as 
a whole, in determining the form of industrial organization 

5 These figures for a year just before the outbreak of the World War 
are in terms of the American gold standard dollar, and are retained 
here as indicating much better than later statistics what may be 
deemed the "normal" situation, in those countries that had the gold 
or silver standards at that time. 

The immense issues of paper money in many of these countries since 
1914, as well as the changed value of gold, has quite altered the 
present status of the monetary stocks. 



20 MONEY AND PRICES [Pt. I 

is enormous. In a society without money industrial processes 
would be very different, and trade would be hampered in 
manifold ways. 

If a poor community has relatively little money it is because 
it cannot afford more ; it gets along with less money than is 
convenient, just as it gets along with fewer agents of every 
other kind than it could use. Pioneers in a poor community 
where the average wealth is low cannot afford to keep a large 
number of wagons, plows, good roads, or schoolhouses. If the 
members of the community were wealthy enough each would 
have more of these and of other things, and the sum total of 
money would be greater. Great as is the convenience of 
money, poorer communities have to do with little of it. It is, 
therefore, a confusion of cause and effect when poor communi- 
ties imagine that their poverty is due to the small amount of 
money in circulation. 

Many of the most common errors in economics are the result 
of confusion as to the real nature and place of money. The 
word "money" is so often usjed, in a figurative sense, for any 
or all of the goods for which it may be exchanged, that men 
forget that it is often a mere symbol of wealth and not the 
wealth itself. To give only two illustrations out of many that 
could be given : In relation to foreign trade, men continually 
speak of bringing money into the country, or of sending our 
money abroad, when in neither case, probably, has any money 
moved in the direction indicated. Again, in reference to the 
interest rate or to the causes of business crises, men speak of 
money being more plentiful or less plentiful, when the amount 
of money has either not changed or has changed in the con- 
trary direction, and what is really meant is that some change 
has occurred in credit conditions. So persistent is this idea 
that there is hardly an economic problem in which this charac- 
teristic monetary illusion does not serve to mislead popular 
opinion. The safest course for the student is to assume al- 
ways that any explanation of processes of production or of 
trade in terms of money is superficial, and that the real forces 



Ch. 2] ORIGIN AND NATURE OF MONEY 21 

and reasons are to be fonnd only by penetrating more deeply 
into the situation. 

§ 9. Standard- commodity money. The actual money in 
use in almost every country to-day consists of a wide and 
confusing variety : gold, silver, nickel, copper, paper in various 
forms, issued by various authorities under various conditions 
as to amount and as to seigniorage. But, among all the kinds, 
in each country some one kind is found standing preeminent 
and in a peculiar position as the standard money to which 
the value of all the othjer kinds of money is in some manner 
adjusted. Usually this standard money is composed of a ma- 
terial (gold or silver) that is a commodity; but there are 
many examples of paper money being for the time the stand- 
ard, "We mean by standard money that kind, no matter what 
its form, which serves in any country as the unit in which the 
value of other kinds of money is expressed. The standard 
usually is a quantity of metal, of a certain weight and fineness, 
which, as a commodity, has a value also in industrial uses. 
Coins of this standard are called full, or real, money by some 
writers who deny the title of money to everything else. Some- 
times the standard may legally be a double one, as in bimetal- 
lism, both gold and silver; but in such cases it actually is 
either gold or silver most of the time. 

The difficulties of the money problem must be attacked at 
the point of standard-commodity monkey, where it is nearest to 
ordinary value problems and is less complicated than when 
the various other kinds of money and the various money sub- 
stitutes are included. 

§ 10. Commodity money without coinage. Let us con- 
sider the problem of money and its value as it would present 
itself if only one kind of commodity money were in use. This 
doubtless was in large measure, if not entirely, the case for 
a time in early societies after one material had proved itself 
to be the best suited for the purpose. The history of many 
kinds of money may, we haV|e seen, be traced back to a point 
where they were not money, but commodities with only a 



22 MONEY AND PRICES [Pt. I 

direct value-in-use. Such were ornaments, shells, furs, 
feathers, salt, cattle, fish, game, and tobacco. Each of these 
materials has, in each situation, a value that is the reflection of 
its power to appeal to choice. Now, if to the commodity-use is 
added the monetary use, this increases the demand for that 
good. No new theory is required to explain the value of a 
commodity as it gradually acquires the added use of a medium 
of trade. The money use is one that works no physical or 
visible change in goods except a slight unavoidable abrasion, 
and at any time a person receiving a piece of commodity 
money may retain it for its use-value as food, ornament, tool, 
or weapon, or may retain it for a time and then spend it as 
money. This case of value is no more difficult than that of 
anj^thing else having two or more uses. For example, cattle 
are used for milk, for meat, and as beasts of burden. Each 
of these uses is logically independent as a cause of value, yet 
all are mutually related, the value of cattle to a particular per- 
son being determined by the consideration of all the uses 
united into one scale of varying gratification. 

In antiquity the metals were used as money in bulk ; that is, 
the amount was weighed at each transaction and the quality 
was tested whenever there was doubt.^ In countries industri- 
ally backward, payments are still made in. this manner. For 
some time after the discovery of gold in Calfornia, gold dust 
was roughly measured out on the thumb-nail. In shipments 
of gold to-day by bankers to settle international balances, 
metal may be in the form of bars that bear the mark of some 
well-known banking house. In all of the cases of this kind 
the gold is money in fact, but not by virtue of any act of gov- 

6 "I will . . . refine them as silver is refined, and will try them as 
gold is tried." (Zech. xiii, 9.) "I bought the field, . . . and weighed 
him the money, even seventeen shekels of silver. And I . . . weighed 
him the money in the balances." (Jer. xxxii, 9, 10.) A shekel was 
224 grains, troy weight, which is about equal to six tenths of the pure 
metal in a silver dollar to-day, and worth in recent years from twenty 
to sixty cents in gold. At that time, however, the purchasing power 
of silver was many times greater than it now is. 



Cir. 2] ORIGIN AND NATURE OF MONEY 23 

erument. The metal is simply a valuable good, the receiver 
of which values it according to its weight and fineness. This 
is true even when the government mint, for a small charge, 
tests and stamps the bars at the request of citizens. 

§ 11. The money-material in its commodity uses. In the 
case of a commodity -money, such as gold, the problem of its 
value as bullion is the same as that of the value of pig iron or 
of zinc, of meat or of potatoes. The value of gold as bullion 
and its value as money are kept in equilibrium by choice and 
by substitution. The several uses of gold are constantly com- 
peting for it: its uses for rings, pens, ornaments, champion- 
ship cups, photography, dentistry, delicate instruments, and 
as a circulating medium. If the metal becomes worth more 
in any one use, its amount is increased there and is corre- 
spondingly diminished in other uses.^ 

This adjustment of the value of commodity-money to 
other things is made also on the side of supply, in the use of 
labor and material agents to produce the precious metals and 
to produce other things. Gold-mining, for example, is one 
among various industries to which men may apply their labor 
and their available material agents. Some mines are superior, 
others medium, others marginal which it barely pays to work. 
There is, therefore, a rise and fall of the margin of gold pro- 
duction, with changes in prices and changes in the cost of 
production. Large new deposits of gold are discovered from 
time to time, and new methods of extracting gold are invented. 
If, when it barely pays to work a mine, such changes occur, 
goild becomes worth less, and the poorer mines eventually must 
go out of use. As gold rises in value some abandoned mines 
again come into use. A similar variation may be noted in the 
utilization of marginal land, marginal factories, marginal 
forges, and marginal agents of every kind.* 

7 See § 1 and § 2 of this chapter; also Vol. I, especially pp. 31-38 
and 353-355. 

8 See Vol. I, pp. 138 flf. and 361 ff. 



24 MONEY AND PRICES [Pt. I 

Eefebences. 

Jevons, W. S., Money and the mechanism of exchange. N. Y. Ap- 

pleton. 1875. Chs. III-VII, XIII. 
Johnson, J. F., Money and currency. N. Y. Ginn & Qo. 1905. 

Chs. I, II, IX. 
Phillips, C. A. (Ed.), Readings in money and banking. N. Y. Mac- 

millan. 1916. Chs. I-III, XIV. 
Walker, F. A., Money in its relations to trade and industry. 1st ed. 

N. Y. Holt. 1879. Chs. I, II. 
White, Horace, Money and banking illustrated by American history. 

Ed. Bost. Ginn & Co. 1914. Bk. I. 



CHAPTER 3 
COMMODITY MONEY AND THE QUANTITY THEORY 

§ 1. Coinage and seigniorage. § 2. Technical features of coinage. 
§ 3. Coined commodity money. § 4. Concept of the individual mone- 
tary demand. § 5. Factors influencing individual monetary demand. 
§ 6. Concept of the community's monetary demand. § 7. Quantity of 
money and prices. § 8. The quantity theory of money. § 9. Inter- 
pretation of the quantity theory. § 10. Practical application of the 
quantity theory. 

§ 1. Coinage and seigniorage. Very early it became the 
practice of governments to shape and stamp pieces of metal 
to be used as money, so as to indicate their weight and fineness. 
The act of shaping and marking metal for this purpose is 
called coinage.^ The coinage by government had notable ad- 
vantages in giving to the monetary units uniformity of size, 
fineness, and value, with the stamp that was readily recog- 
nized. But in its simplest form coinage in no way changed 
the value of the money, and any other mark equally plain put 
upon it would have served equally weill, if only it had carried 
with it equal assurance of the quality and weight of the metal. 

Coinage, as practised by early governments and rulers, came 
to be a function of great importance politically as well as eco- 
nomically. The right to issue money came to be one of the 
most essential prerogatives of sovereignty. The prince, king, 
or emperor stamped his own device or portrait upon the coin ; 

1 From the French min, in turn from Latin cuneus, wedge, suggestive 
either of an earlier wedge-shaped piece, or of a wedge-shaped mark on 
the piece. The German word Miinze is from the Latin moneta (as is 
the English mint, the place where coins are made), which meant money, 
that name being taken from the temple Juno, called Moneta, where 
coins are made. 

25 



2G MONEY AND PEICES [Pt. I 

hence the term seigniorage from seignior (meaning lord or 
ruler). Seigniorage meant primarily the right the ruler, or 
the estate, has to charge for coinage, and hence it has come to 
mean also the charge made for coinage, and often, in a still 
broader sense, the profit made by the government in issuing 
any kind of money with a value higher than that of the ma- 
terials (whether metal or paper) composing it. Coinage is 
rarely without charge, and often has been a source of revenue 
to the ruler. In antiquity and in the Middle Ages this right 
was frequently exercised by princes for their selfish advan- 
tage to the injury and unsettling of trade. This introduced 
a very great problem of value into the use of money. 

The coinage is said to be gratuitous when no charge is made 
for coinage. Coinage is said to be free if the subject or 
citizen may take bullion to the mint whenever he pleases, 
paying the usual seigniorage. Coinage is limited if the gov- 
ernment or ruler determines when coinage is to take place. 
Thus, coinage may be both free and gratuitous, when citizens 
are allowed to bring bullion whenever they please and have it 
converted into coins without charge or deduction. But coin- 
age is free without being gratuitous when any citizen may 
bring metal to the mint, whenever he chooses, to be coined 
subject to the seigniorage charge. 

§ 2. Technical features of coinage. For each kind of 
metal money there is an established ratio of fineness for the 
more precious material, which is mixed with baser metals used 
as alloys. In the United States all gold and silver coins are 
made nine tenths fine; in Great Britain, eleven twelfths. 
The established weight of the gold dollar in the United States 
is 25.8 grains of standard gold which contain 23.22 grains of 
fine gold. The limit of tolerance is the variation either above 
or below the standard weight or fineness that a coin is allowed 
to have when it leaves the mint. This is different for each 
of the principal coins, being about one fifth of one per cent 
on a gold eagle. The par of exchange between standard 
coins of different countries is the expression of the ratio of 



Ch. 3] COIMMODITY MONEY AND THE QUANTITY THEORY 27 

fine metal in them. Thus the par of exchange between the 
American dollar and the English sovereign (the ''pound") is 
4.866 ; that is, that number of dollars contains the same amount 
of fine gold as an English gold sovereign. The embossed 
design is to make the coins easily recognizable and difficult to 
counterfeit ; and milled or lettered edges are to prevent clip- 
ping and otherwise abstracting metal from coins. 

§ 3. Coined commodity money. When coinage is free and 
gratuitous the standard money is a commodity. Such coin- 
age is essentially but the stamp and certificate that the coin 
contains a certain weight and fineness of metal. "Where coin- 
age is free and gratuitous - each coin will be worth the same 
as the bullion that is in it, as far as the citizens exercise their 
choice. They will not long keep uncoined metal in their pos- 
session when it is worth more in the form of money, nor will 
they long keep money from the melting-pot when it is worth 
more as bullion. Yet there may be a slight disparity between 
the bullion value and the monetary value before the metal 
is converted into coin or the coin melted down into metal. 

Let us take a case where gold is in general use as money, and 
where for some time there has been no noticeable change in the 
amount of business and in methods of trade. What would 
happen when new gold-mines were found that were much 
easier to operate, and gold began to be produced at a much 
more rapid rate than formerly ? The amount of gold as com- 
pared with other forms of Vv^ealth evidently would be increased. 
If all the increased amount went into the industrial arts, the 
value of gold in its industrial uses would fall below its value 
in monetary uses. Then a part of the increased amount must 
be diverted to monetary uses. When any man, by reason of 
the increasing gold supplies, gets a larger stock of money than 
he had before, the proportion formerly existing between his 

2 This means actually gratuitous, for any real difficulty in getting 
metal to or from the mint operates as a cost in the conversion of bullion 
into money, or vice versa; e. g., the gold may be in Australia and the 
mint in London. 



28 MONEY AND PRICES [Pt. I 

use for money and his monetary stock is altered. He has more 
money than meets his monetary demand at the existing prices. 
As he seeks to reduce his stock of money to due proportions 
by buying more goods, he thereby distributes a part of the ex- 
cess of money to others. This bids up the price of goods 
further until the total value of goods exchanged again bears 
the same ratio as before to the average monetary demand of 
each individual. 

§ 4. Concept of the individual monetary demand. Let 
us now seek to get in mind the idea of an individual monetary 
demand, as that amount of money which at any time is re- 
quired by an individual to make his purchases in expending 
his income. Every man may be thought of as having an aver- 
age monetary demand, or his average individual cash re- 
serve, throughout a period. A man with a salary of $50 
a month paid monthly has ordinarily a maximum monetary 
demand of $50. If his expenditures are made in two equal 
parts, the one on pay-day, the other thirty days later, his 
average monetary demand during the month is a little over 
$25. If most of his purchasing is done in the first week 
of the month, his average monetary demand may be per- 
haps $10. Many a workman purchases on credit, running ac- 
counts at the stores for a month. Then on pay-day he 
spends his entire month's wages the day he receives it, and 
goes without money for the rest of the month. His average 
monetary demand throughout the month would then be about 
equal to one day's wages. Evidently any person's cash re- 
serve may be expressed as that proportion of his income that 
is to him of more value retained in money form for any 
period than if at once expended. 

Every moment beyond the average time that any one keeps 
money increases his monetary demand. If he delays a day, a 
week, or a month in spending the money, waiting until he can 
buy in some other market or until a better time to buy, he 
thus increases insomuch the amount of money needed to make 
the trade (on that scale of prices). It requires more slow 



Ch. 3] COMMODITY MONEY AND THE QUANTITY THEORY 29 

dollars than swift dollars to make a given volume of pur- 
chases. 

§ 5. Factors influencing individual monetary demand. 
In this conception of the individual monetary demand must, 
however, be included not merely the demands of retail pur- 
chasers, made by themselves, but also those of all agencies, 
such as merchants, bankers, and transportation companies, 
serving the needs of ultimate consumers of goods. The use 
of money may be necessary several times before a commodity 
completes its journey from producer to consumer. 

Of two persons whose expenditures of money are of the 
same kind and made at the same rate, the one having the larger 
amount of purchases to make has the larger monetary demand. 
(But the amount of purchases does not always vary directly 
with the amount of real income ; ^ for example, a farmer and 
a village mechanic may have at their disposal incomes equal 
in the quantities of goods, such as food, fuel, clothing, and 
house-uses (worth, let us say, $1000 for each), but the farmer 
would be getting a larger part of his goods directly from his 
farm and by his own labor, while the mechanic would be 
getting first a money income to be expended afterward for 
food, clothing, and rent. The mechanic would in this case 
have an average monetary demand much larger than the 
farmer. 

We see thus that the individual monetary demand at any 
time is that amount of money which rests in his possession as 
the necessary condition to making his purchases as he desires. 
Individual monetary demand varies in proportion directily 
to the delay, and inversely to the rapidity with which the 
individual passes the money on; and directly to the amount 
of the person's income that is received and expended in 
monetary form. 

§ 6. Concept of the community's monetary demand. The 
monetary demand of a community at a given time is the sum 
of the monetary demands of the various individuals and en- 

3 See on kinds of income, Vol. I, p. 26 fF. 



30 MONEY AND PRICES [Pt. I 

terprises. It is that stock of money which is necessarily 
present to effect the exchanges of the community in the pre- 
vailing manner at any given level of prices. A single dollar 
as it circulates helps to supply the monetary demand of many 
individuals in turn : the more quickly each person spends the 
piece of money he receives, the greater its rapidity of circu- 
lation. Let us suppose that every piece of money passed 
from one person to another once each day. Then a dollar 
would, in the course of a business year (about 300 days), 
serve to buy (and at the same time to sell) $300 worth 
of goods. If the average purchases of each individual 
amounted to $1000 a year, the average monetary demand of 
each would be about $3.33i^. 

The times of maximum monetary demand of the different 
individuals do not coincide; often they alternate with each 
other, and the community 's total monetary demand at a given 
time is a composite of the many individual variations. The 
amount of money that will remain in circulation in a com- 
munity depends on several factors, the chief among them be- 
ing the amount of goods to exchange, the methods of exchange, 
and the value of the commodity material in other uses. The 
amount of goods to be exchanged may change even when the 
amount produced is unaltered (e. g., a change from agricul- 
tural to industrial conditions). The methods of exchange 
may alter so as to require either more money (e. g., cash in- 
stead of credit business) or less money (e. g., use of bank 
checks displacing use of money by individuals). Or, apart 
from the other factors, the scale of prices may change as the 
conditions of commodity money production are altered. 

§ 7. Quantity of money and prices. Consider the effect 
of a large and rapid increase in the production of gold in a 
community where the gold dollar is the standard commodity 
money. At first some few men, the miners, may have far 
more dollars than before, while most men have nearly the 
same number as before. But those nearest the miners and 
selling to them will get more dollars, which they will pass 



Ch. 3] commodity money and the quantity theory 31 

on to others, and thus, in ever-widening circles, the in- 
creased supply of gold will spread until a new equilibrium 
of the monetary value is attained, when every one will have 
got his due proportion of the new supplies. If the number 
of dollars has been doubled, every one will, in the long run, 
and "other things being equal," have twice as many dol- 
lars as before. 

Now, prices of goods cannot remain the same as before; 
for if they did there would be twice as many pieces of 
money available to effect the same number of trades at the 
same prices. There is no reason why each person should 
tie up twice as large a yroportion of his income in the form 
of money. If, however, there is a concerted movement to 
spend the surplus money, there results a general bidding 
down of the value of money, a general bidding up of the 
prices of goods and of services. At what point will this 
movement stop ? The rational conclusion must be that, other 
things being equal, the new equilibrium will be established 
when the ratio between the value of money and the price 
of the goods that each individual is purchasing becomes the 
same as before. The money in a community being doubled, 
prices must be doubled, and proportionally for any other 
change in the quantity. 

§8. The quantity theory of money. This explanation 
of the effect of changes in the quantity of money in a country 
upon prices (the general scale of prices) is known as the 
quantity theory of money. This theorj^ has, for a century, 
been very generally accepted by competent students of the 
money problem. It may be summed up thus: other things 
being equal, the value of the monetary unit, expressed in 
terms of all other commodities, falls as the quantity of 
money increases, and vice versa. That is, prices rise and 
fall in direct proportion to changes in the total quantity. 
This is a simple explanation of a complex and difficult set of 
conditions. The phrase, "other things being equal," be- 
tokens the statement of a tendency where there are several 



32 MONEY AND PRICES [Pt. I 

factors. The quantity theory explains what happens when 
there is a change in one of the factors — the number of pieces 
of money. There are three large sets of facts to be brought 
into relationship with each other in the quantity theory: 

(1) the amount of business, or the number of trades effected; 

(2) the rapidity of circulation, depending on the methods 
by which business is done; (3) the amount of money avail- 
able. According to the quantity theory, we must expect that, 
when conditions (1) and (2) remain fixed, prices (the gen- 
eral price level) will vary directly, and the value of money 
will vary inversely as the quantity of money. This quan- 
tity theory may be expressed in the formula P = - — when 

N 
P is the symbol for price, or the general price level, N is 
(1) above, R is (2), and M is (3). P, therefore, changes 
directly with either M or R, or inversely with N.* 

§ 9. Interpretation of the quantity theory. The quan- 
tity theory must be carefully interpreted to avoid various 
misunderstandings of it that have appeared again and again 
in economic discussion, 

(1) It does not mean that the price level changes with 
the absolute quantity of money, independently of growth of 
population and of the corresponding growth in the volume 
of exchanges. 

(2) It is not a mere per capita rule to be applied at a cer- 
tain moment to different countries. For example, Mexico 
may have $9 per capita and the United States $35, while av- 
erage prices may not differ in an3d:hing like that proportion. 
But in these two countries not only the amounts of exchanges 
per capita but the methods of exchange and the rapidity of 
the circulation of money differ greatly.^ 

(3) It cannot be applied as a per capita rule to the same 
country through a series of years, without taking account of 

4 This formula is presented by E. W. Kemmerer in "Money and 
Prices" (2d ed., 1909), p. 15 ff. 

5 See table in ch. 2, § 7. 



Ch. 3] COIVIMODITY MONEY AND THE QUANTITY THEORY 33 

the many changing factors. It is estimated that in 1800 the 
money stock was about $5 per capita in the United States, 
and in 1914 about $35 ^ but average prices have not neces- 
sarily changed in the same ratio. In a period of years a 
country may change in a multitude of ways, in complexity 
of industr}^, modes of exchange, transportation, wealth, and 
income. These changes require some larger, others smaller, 
per capita amounts of money to maintain the same level of 
prices. For example, the substitution of cash paj'ments for 
book-credit in retail trade is equivalent to increasing N in 
the formula; whereas an increased use of banks and check- 
ing accounts, by economizing the use of money, enables a 
smaller amount of money to maintain the same level, and 
may be considered as increasing R in the formula.'^ 

(4) Tho applied originally to standard money, the quan- 
tity theory applies to all other kinds of money circulating 
side by side and at a parity of value, as far as these fulfil 
the definition of money and are not merely supplementary 
aids to money. These supplementary forms of money en- 
able each standard dollar to do more work, to circulate more 
rapidly. If the standard money alone were doubled in quan- 
tity, while the various forms of fiduciary money (smaller 
coins, banknotes, government notes) remained unchanged, 
the quantity of money as a whole would not be doubled. In- 
deed, in such a case the method of exchange would be greatly 
altered. According tq_the quantity theory, therefore, prices 
would not be expected to double. 

§ 10. Practical api:!i:ation of the quantity theory. De- 

6 Per Capita Circulation^ of Money (Estimated) in the United 
States in Various Years. 

1800 $4.99 1850 $12.02 1900 $26.0.1 

1810 7.f50 1860 13.85 1910 34.33 

1820 6.96 1870 17.51 1915 35.44 

18.30 6.78 1880 19.41 1920 57.18 

1840 10.91 1890 22.82 

' On the function of deposits see ch. 7, § 11. 



34 MONEY AND PRICES [Pt. I 

spite the mimber of changing factors affecting the methods 
of exchange and the amount of business, the quantity theory 
is a rule usable at any moment. These various factors 
change slowly, and the quantity theory answers the question : 
What general change occurs in prices as a result of the in- 
crease or decrease of the money in a given community at a 
given moment? Like the law of gravitation and the law of 
projectiles, the theory must be interpreted with relation to 
actual conditions. 

The quantity theory makes intelligible the great and rapid 
changes in prices which have followed sudden changes in the 
quantity of money. Inductive demonstration of broadly 
stated economic principles is usually difficult, but there have 
been many "monetary experiments" to teach their lessons. 
Many inflations and contractions of the circulating medium 
have occurred, now in a single country, again in the whole 
world; and the local or general results have helped to ex- 
emplify richly the working of the quantity principle. "With 
the scanty yield of silver- and gold-mines during the Middle 
Ages, prices were low. After the discovery of America, es- 
pecially in the sixteenth century, quantities of silver flowed 
into Europe. The great rise of prices that occurred was ex- 
plained by the keenest thinkers of that day along the essen- 
tial lines of the quantity theory, tho there were many 
monetary fallacies current at that time. The experience in 
England during the Napoleonic wars, when the money of 
England was inflated (by the forced issue of large amounts 
of banknotes) and prices rose above those of the Continent, 
led to the modern formulation of the theory of Kicardo and 
others about 1810. The discovery of gold in California and 
Australia in 1848-^0 greatly increased the gold supply, and 
gold prices rose throughout the world. Between 1870 and 
1890 the production of gold fell off while its use as money 
increased greatly, and prices fell. A great increase of gold 
production has occurred in the period since 1890. The wave- 
like movements of prices since 1897 are explicable as the 



Cn. 3] COMMODITY MONEY AND THE QUANTITY THEORY 35 

periodic up and down swings of confidence and credit, but 
in the main the general trend upward has been due to the 
stimuilus of increasing gold supplies.* These are but a few of 
many instances in monetary history, which, taken together, 
make an argument of probability in favor of the quantity 
theory so strong as to constitute practically an inductive 
proof. 

8 Consult Figures 1 and 2 in chapter 5 for the graphic presentation 
of these and related facts. 

References. 

Fisher, Irving, The purchasing power of money. N. Y. Macmillaii. 

1913. 
Johnson, J. F., Money and currency. N. Y. Ginn. 1905. Chs. III- 

VIII, X. 
Eemmerer, E. W., Money and credit instruments in their relation to 

general prices. 2d ed. N. Y. Holt. 1909. 
Phillips, G. A., Readings in money and banking. N. Y. Macmillan. 

1916. 
Walker, F. A., Money. N. Y. Holt. Chs. IV, V. 



CHAPTER 4 



FIDUCIARY MONEY, METAL AND PAPER 

§ 1. Character of fiduciary money. § 2. Present monetary system 
of the United States. § 3. Saturation point of fractional money. 
§ 4. Light-weight fractional coins. § 5. Gresham's law. § 6. Seign- 
iorage on standard money. § 7. Fiduciary coinage on governmental 
account. § 8. Two stages of coinage debasement. § 9. The gold-ex- 
change standard. § 10. Nature of governmental paper money. § 11. 
Irredeemable paper money in America, § 12. Irredeemable paper 
money in Europe. § 13. Theories of political money. § 14. Political 
money; theory and practice. 

§ 1. Character of fiduciary money. The actual moneys 
in circulation in every modern country consist of a wide 
variety of pieces, differing in denomination, physical size, 
shape, and materials, mode of issue, source or authority of 
issue, and legal character. Among these kinds, one is usually 
the standard money and usually is a commodity. The ex- 
ceptions indicated by the word ''usually" are (a) that un- 
der the plan of bimetallism, two metals may be legally des- 
ignated as the standard, making in fact an alternative 
standard, called, however, a double standard; and (b) that 
an irredeemable paper money may be, for the time, the stand- 
ard money. The coinage of standard money often is free and 
gratuitous (or nearly so), and the value of the money is kept 
close to parity with its value as bullion by changing bullion 
into coin, or coin back into bullion, whenever there is an ap- 
preciable difference between the value in the two uses. This 
adjustment is brought about by the free action of the people. 
The government, having declared what is the standard money 
unit, and having provided a mint to make coins, leaves it to 
citizens, acting on the ordinary business motives, to decide 

3G 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 37 

when they will reduce or increase the number of coins in 
circulation. 

The other kinds of money are not commodity money, and 
the materials of which they are made, whatever they may 
be, are not worth as much in any other uses as they are in 
their present monetary form. Their value is always referred 
to, and adjusted to, that of the commodity money, as long 
as any of it is in circulation. In contrast with commodity 
money, these other kinds may be called fiduciary money. By 
fiduciary money we mean money that has not a commodity 
value equal to its money value, but which is generally ac- 
cepted because each receiver has faith that others in turn 
will take it in the same way. The faith {fides) is not always 
that the issuer of the money (whether it be a bank or the 
government) will redeem the money on demand at any 
future time; for fiduciary money may circulate while irre- 
deemable, that is, either carrying no promise of redemption 
in the standard money or in fact not being redeemed. Yet 
often actual redemption on demand or a good prospect of 
future redemption is one of the circumstances stimulating 
the faith and the readiness of each person in turn to receive 
fiduciary money. 

§ 2. Present monetary system of the United States. In 
the following table is given a summary of the main features 
marking the monetary system of the United States in 
1920. 

Not all this variety is essential to an efficient monetary 
sj^stem, and several of the kinds survive as the result of his- 
torical accidents (political and legislative). But all are now 
kept in accord with the value of the gold coin, which, it 
will be observed, is the only kind the amount of which is not 
artificially limited. Silver dollars are no longer coined, 
subsidiary silver and minor coins are issued only in exchange 
for other money, as are gold and silver certificates in ex- 
change for gold or for silver, which they merely represent 
while in circulation. 



38 



MONEY AND PEICES 



[Pt. I 



MONETARY SYSTEM OP THE UNITED STATES. 1920 



Metals 


Weight, grains 


Fineness 


Ratio to gold 


1. 




25.8 

412.5 

385.8 

77.0 

48.0 


.90 
.90 
.90 
.25 
.95 


100 


2. 
3. 
4 


Silver dollar 

Silver, subsidiary . 
Nickel (5 cents) . . 
Copper (1 cent) . . . 


15.988 to 1 
14.953 to 1 


5. 




Metal 


Limit of issue 


Legal tender for 
private debts 


Receivable for 
public dues 


1. 
2. 
3. 

4. 
5. 

6. 

7. 

8. 
9. 


Gold coins 

Silver doUar 

Silver, subsidiary . . . 

Nickel (5 cents) . . , 
Copper (1 cent) . . . 

Paper 
Gold certificates .... 

Silver certificates . . . 

U. S. notes 

Treasury notes of 
1890 


Unlimited. 
Ceased in 1905 
In exchange for 
other forms 

Do. 

Do. 

Unlimited in ex- 
change for gold 
coin. 

In exchange for 

silver dollar 
No new issues. 

No new issues. 
Capital of banks 
To replace 

Nat. bank-notes 
Per cent, of 

gold reserves. 


Unlimited. 
Unlimited. 
$10 

25 cents 
25 cents 

Yes (since 1919) 

No 

Yes 

Yes 
No 

Same as 

Nat. bank-notes 

At banks of re- 
serve system 


For aU 
For aU 
$10 

25 cents 
25 cents 

For all 

For aU 

Except customs 
For all 


10. 
11. 

12. 


National bank-notes . 
Federal Reserve notes 

Federal Reserve notes 


Except customs 
Same as Nat. 
bank-notes 
For all 


Metal 


Exchangeable at 
Treasury for 


Redeemable at 
Treasury vn, 


In circulation 
June 30. 1920 


1. 

2. 
3. 

4. 


Gold coins 

Silver dollar 

Silver, subsidiary . . 

Nickel 


Gold certificates, 
U. S., Treas., or 
Fed. Res. notes. 
Silver certificates 
Minor coins 

Subsidiary and 

minor coins 
Silver and 

minor coins 
Subsidiary and 

minor coins 
Silver and 

minor coins 
Subsidiary silver 
and minor coins 
Same 
Gold" 


Lawful money," 
in sums or mul- 
tiples of $2( 1 
Do. 1 

Do. J 

Gold coin 

Silver dollars 

Gold 

Gold 

Lawful money * 

Same 
rJold" 


839,000,000 
134,000,000 
252,000,000 


5. 


Copper 


96,000,000 ^ 


6. 
7. 
8. 
9. 


Paper 
Gold certificates .... 

Silver certificates .... 

U. S. notes 

Treasury notes of 
1890 


391,000,000 • 
118,000,000 T 
337,000,000 
1,656,000 


10. 

11. 

12. 


National bank notes. 

Fed. Res. bank-notes. 
Federal reserve notes 


696,000,000 

199,000,000 

3,120,000.000 




Total « 




6,183,656,000 



" ''Lawful money" includes gold coin, gold certificates, silver dollars, U. S. notes, 
and Treasury notes. 

" Redeemable also in lawful money at bank of issue. 

"Redeemable also at Federal Reserve banks in gold. ' 

"Not usually included in the estimates of total monev in circulation. 

« Represented dollar for dollar by gold kept in the U. S. Treasury. 
Represented dollar for dollar by silver kept in the U. S. Treasury. 
. Besides, there were about $464,000,000 in gold and $22,000,000 in silver, 
in the US. Treasury, mints, and Federal Reserve banks, not offset by gold and 
silver certificates, respectively. 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 39 

§ 3. Saturation point of fractional money. Fiduciary 
money is that on which regularly the issuer makes a seign- 
iorage charge.^ Let us consider now the effect of seigniorage 
on the value of money. 

Fractional coins, called also subsidiary coins, are those of 
smaller denominations than the standard unit of money, as 
shillings and pence in England, and half dollars, quarter 
dollars, dimes, nickels, and cents in America. Money to 
serve well a variety of uses must be of different denomina- 
tions, and "small change" is necessary to make small pur- 
chases and for exact settlement in larger payments that are 
not multiples of the standard unit. The amount required 
(or most convenient to use) in each denomination of frac- 
tional coins is thus a more or less certain portion of each 
person's monetary demand, shaped by experience and fixed 
by habit. For example, within certain elastic limits of con- 
venience quarters may be used for halves, and dimes for 
nickles (and vice versa) ; but each person has a point of pref- 
erence. The total demand for each kind of change is the 
sum of the individual demands. This point where the 
amount of coins of any denomination (in relation to the 
whole monetary system) is most convenient may be called the 
saturation point of that kind of small change, up to which 
point the people prefer a share of their money in that form, 
and beyond which they will, if free to choose, exchange that 
kind for other denominations (smaller or larger). Each kind 
of money, as the cent, nickel, dime, has its own peculiar 
demand and its saturation point. 

§ 4. Light-weight fractional coins. The standard metal is 
usually too valuable to be suitable for coins of the smaller 
denominations. Therefore, when gold is the standard, copper, 
nickel, and silver remain in use for small transactions. But 
if coins of these metals are issued at weights corresponding 
with their bullion value, difficulties often arise. Not only are 
they too heavy for convenience, but with every slight rise in 

1 In the broad sense as before defined, ch. 3, § 1. 



40 MONEY AND PRICES [Pt. I 

their bullion value as compared with that of the standard 
metal, they become worth more as bullion than as coin and 
beg-in to disappear from circulation. This happened often 
throughout the Middle Ages and until the nineteenth century. 
The attempt was frequently made to coin gold and silver at a 
ratio of weight corresponding exactly to their market values 
at the time and, every time the market conditions varied, the 
best full- weight coins of one of the two metals were taken out 
of circulation; whereas the worn coins might remain in cir- 
culation.^ Business thus often suffered for lack of the proper 
proportion of the various denominations of coins. At length, 
to remedy this difficulty, fractional silver coins, often called 
"token coins," were issued, in limited numbers, of less than 
full proportionate weight and bullion value, as compared with 
the standard commodity money. 

This plan, having been partially tried, was generally 
adopted by the United States in 1853 at a time when the silver 
dollar of 871.25 fine grains was legally rated at the same value 
as the gold dollar of 23.22 grains, and was freely coined. 
The fractional coins were made a little more than six per 
cent lighter per dollar than the dollar coin ; two half dollars 
or four quarters or ten dimes contained 93.52 cents' worth of 
silver. Later silver bullion became worth much less in terms 
of gold, and for years the bullion value of the silver in a dollar 
of silver small change was between forty and sixty cents. 
Yet the fact that fractional coinage continued to circulate 
and exchange freely at parity with standard money showed 
that it had a monetary value equal to the standard money, 
dollar for dollar. Why was this? 

The answer is, because it is artificially limited in quan- 
tity, so that it does not pass the point of saturation in the 
field of its use. Its value rests on its monetary use; it is 
fiduciary money, not commodity money. It is limited simply 
by letting "the needs of the people" determine its amount. 
This is done by issuing it only in exchange for other money 

2 See next section on worn coins in connection with Gresham's law. 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 41 

of the larger denominations, and by redeeming it in other 
money on demand. Mostly, fractional coins are issued by the 
mints on the request of banks. One needing "change" gets 
it at the bank; when the bank finds its supply falling short 
it gets more in exchange for other forms of money, as shown 
in the table of the monetary system. As business increases 
in a period of prosperity, the demand for nickels, dimes, and 
quarters rises, and the mints work night and day to supply 
the need. If these coins were made in great quantities and 
forced into circulation by the government through paying 
them out to creditors and officials, their quantity would be- 
come excessive and they would fall in value (be at a discount) 
compared with standard money. But as this is not done, 
and as, moreover, they are redeemed on demand at the Treas- 
ury (and practically at every bank and post-office) in other 
money, any slight tendency to depreciation in any locality 
is at once corrected. The fractional coinage is maintained 
at a parity with the standard money in accordance with the 
monopoly principle, expressed in the limitation of the 
amount. The government makes a seigniorage profit on the 
fiduciary coinage, as shown in the appended table.^ 

OPERATIONS OF THE U. S. MINT SERVICE, 1920 

Receipts: 

Charges for refining, assaying, manufacture for other 

countries, etc $068,000' 

Profits on seigniorage, subsidiary and minor coinage.... 12,333,000 

Total receipts 12,901,000 

Expenditures : 

All kinds 2,377,000 

Net revenues from mint service 10,524,000 

§ 5. Gresham's law. Coins may be light weight as the 
result of another cause — namely, the abrasion (wearing off) 
of the coins in circulation. Nearlj^ always when this has 
occurred the worn coins have still been accepted as money, 
and ordinarily without any depreciation. It makes no differ- 

3 Receipts and Expenditures of Mint Service in 1920. 



42 MONEY AND PRICES [Pt. I 

ence what may be deemed the cause of their acceptance; 
whether it be habit, public opinion in business circles, or the 
act of law making them a legal tender; the essential thing is 
that they continue to be accepted as money. They have a 
value as money greater than the value of the bullion that is 
in them. Yet everybody takes them without hesitation as 
readily as if they were full weight. If, however, at this 
point, new full-weight coins are put into circulation, these 
at once disappear while the old worn coins remain in circula- 
tion — a fact that in medieval times was found both mystify- 
ing and annoying. 

In explanation of this phenomenon was formulated Gres- 
ham's law of the circulation side by side of coins of differ- 
ent bullion value: bad money drives out good money. Sir 
Thomas Gresham (whose name has but recently been given 
to this so-called law) explained the principle to Queen Eliza- 
beth when counseling her regarding the recoinage of the de- 
based money of the realm, as was done in 1560. He showed 
that when old worn coins were in circulation and the mint 
began putting out full-weight coins, the old lighter ones re- 
mained as money, while the new ones, being heavier, were 
picked out by jewelers and others needing to send money 
a,broad, 

Gresham 's law has a paradoxical wording and is frequently 
misunderstood. "Bad money," as he used the term, meant, 
not counterfeit money, but merely worn coins that have a 
bullion value less than that of some other money then in 
circulation. But such ''bad money" will not always drive 
out ''good money." The law applies only under certain 
conditions and within certain limitations. The "good" will 
be driven out only if the total amount of money in circula- 
tion is in excess of what would be needed if all were of 
full weight and of best quality. Paradoxically speaking, if 
there is not too much money altogether, the bad money is 
just as good as the good money. But, even if good money is 
driven out, it may ttiot leave the teountry. It may bei 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 43 

hoarded, or be picked out by banks and savings institutions 
to retain as their reserves, or be melted for use in the arts. 
Gresham's "law" becomes thus a practical precept. As ap- 
plied to the plan of recoinage it is: Withdraw worn coins 
as rapidly (in equal numbers) as you put new coins into 
circulation. 

The continued circulation of "bad" money alongside of 
"good" money (light-weight alongside of full-weight coins), 
as long as the total number of coins is not in excess of the 
money demand for full-weight coins, is explained thus on 
exactly the same principle as is the circulation at parity of 
a light-weight fractional coinage, in the preceding section. 

§ 6. Seigniorage on standard money. The fiduciary 
coinage problem presents itself under a somewhat different 
guise in case a seigniorage charge is made on all coinage, 
even of that metal used as the standard unit. In this case 
coinage might be free but not gratuitous. Then no bulilion 
would be brought to the mint unless the coined pieces the 
owners received had a value equal to the bullion value plus 
the seigniorage charge. The power to impose a seigniorage 
charge is a monopoly power, a power of artificial limitation. 
The number of coins that can be issued without depreciation 
is limited to that number which would circulate if they were 
made full weight without a seigniorage charge. With this 
number of pieces, the money demand of the country is at the 
saturation paint for full-weight metal coins. If more coins 
could in any way be put into circulation they would be 
worth less as money than as bullion, and would be melted or 
exported. 

Assume that this full supply of gold money at the satura- 
tion point is 100,000 pieces or dollars; then consider the 
effect of imposing a seigniorage charge of 10 per cent on 
further coinage. If business or population did not increase, 
and until through loss, by fire and in other ways, and 
through use for industrial purposes, the quantity of money 
had been reduced below this point, the seigniorage charge 



44 MONEY AND PRICES [Pt. I 

would have no effect, and there would be no desire to change 
gold from bullion form into coin. But Avhen any or all of 
these suggested changes take place, the value of the mone- 
tary unit relative to the bullion value will begin to rise. It 
will take on a monopoly value due to the limitation of coin- 
age. When it has risen until the coin will buy any more 
than one ninth more bullion than was in it, the citizens will 
begin to take metal to the mint. After the 10 per cent 
charge is taken out they will receive a coin which, though 
containing one tenth less bullion, will be worth very nearly 
the same as the metal taken to the mint. No depreciation 
could take place unless the volume of business fell off so that 
less money was needed than before. In that case there would 
be no outlet for the excess of coins until they fell to their 
bullion value, i. e., till they lost the entire value of the seign- 
iorage, the monopoly element in them. Melting or exporting 
them before that point was reached would cause to the owner 
the loss of whatever element of seigniorage value they con- 
tained. 

We thus have arrived at the general principle of seignior- 
age: when coins are not issued beyond the saturation point, 
a seigniorage charge raises the monetary value of the money- 
material above its bullion, that is, its commodity, value. And 
this holds good of a large seigniorage charge as well as of a 
small one, even up to the extreme limit of a charge of 100 
per cent. In this last case the government would retain the 
whole of the bullion brought to it and would give in return 
a piece of money made of material (metal or paper) with a 
negligible value. 

§ 7. Fiduciary coinage on governmental account. The 
fiduciary coinage problem may be presented also when coin- 
age is not free, and the times and amount of coinage are 
determined by law or by legally authorized officials. In this 
case the bullion must be obtained by purchase in the open 
market (and paid for by some form of legal money, or by 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 45 

bonds). Coinage is then said to be "on governmental 
account. ' ' 

Now, assuming that the normal money demand (the volume 
of business or sum of exchanges) remains unchanged, let us 
consider what will result if the government begins to issue 
money in this way when, as in the preceding case, 100,000 
units of full-weight money are in circulation. This action 
might be taken most simply by recoining all the full-weight 
pieces that came into the treasury, making them contain 
one tenth less precious metal, and paying out 1111 pieces 
for every 1000 received. Every time this was done there 
would be an exce,ss of 111 pieces above the normal money 
demand, and 111 full-weight pieces would be exported or 
melted (Gresham's law). The process (in strict theory) 
may be repeated 90 times, at which point 90,000 full-weight 
coins have been received, 100,000 light-weight coins have been 
issued to take their place, and 10,000 full-weight coins have 
gone out of circulation. The total seigniorage profit would 
be one-tenth of 90,000, or 9,000 units. No depreciation has 
taken place,^ the pieces, by reason of their limitation, bear a 
money value in excess of the bullion that is in them. 

Now the government, with the next 1000 pieces collected 
by taxation, could buy enough bullion (in the open market) 
to make another 1111. The excess of 111 pieces could not now 
be promptly removed by the melting down or exporting of 
111 coins, for all those remaining in circulation have a bul- 
lion value one tenth balow tlieir money value. As this proc- 
ess is repeated the number of coins must continue to grow 
from 100,000 to 111,111, and the value of the money piece in 
terms of bullion continue to fall from ten to nine. At this 
point the 111,111 pieces would contain just the same amount 

4 In this and following numerical examples no account is taken of 
the possibility that the standard metal may depreciate in the world 
market in terms of all other goods as a result of its diminished use 
as money in one or more countries. This properly bel'^^gs in a more 
complete theoretical treatment of the subject. 



46 MONEY AND PRICES [Pt. I 

of bullion and have just tlie same value as the 100,000 pieces 
did before. Thereafter no further profit would accrue to the 
government from issuing coins of that weight. To make 
a further profit it must again reduce the amount of pure 
metal in the coin. 

§ 8. Two stages of coinage debasement. It will be seen 
that, taking the number of full-weight coins at the saturation 
point as parity (when price is 100), then (a) price rises 
directly as the number of units of money; (b) the value of 
the monetary unit is the reciprocal of price (changes in- 
versely with the number of units of money). 

When a new seigniorage charge is imposed, the change 
in the physical content of the coin is called debasement. Two 
stages of this change may be distinguished (as is shown in 
the preceding description). The first stage is debasement 
without depreciation of the monetary unit ; the second stage 
is debasement with depreciation. In the first stage the mone- 
tary unit, as a result of limitation, has an artificial value in 
excess of its bullion value; in the second stage its monetary 
value falls toward its bullion value, but may (depending on 
limitation) rest anywhere between the former full-weight 
bullion value and the new bullion-content value. 

The process illustrated above was often repeated in the 
Middle Ages. A ruler, either by making a higher seignior- 
age charge or by coining on his own account, debased the 
quality or reduced the weight of the money of his realm. For 
a time the new coins, having the same monetary use, circu- 
lated at par with the old coins. The ruler, pleased with this 
almost magical power of getting a revenue with little trouble, 
continued to issue coins, until suddenly the heavier coins be- 
gan to be exported or melted, and the value of the other 
money fell, to the mystification alike of the prince and of his 
people. The reason is now perfectly plain: the number of 
coins was not kept within the proper limits and they went 
down to their bullion value. The only way a further profit 
could be made in this way was to debase the coin again. By 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 47 

successive steps the coinage came to consist almost entirely 
of cheaper alloy. 

§ 9. The gold-exchange standard. In a number of silver- 
using countries and colonial dependencies near the end of the 
nineteenth century, the fluctuations of the value of silver in 
terms of gold was a constant source of difficulty in the pay- 
ment of foreign obligations to gold standard countries. Yet 
there were strong reasons in the habits of the people and in 
the industrial conditions of the country to prevent the adop- 
tion of gold and the disuse of silver as the actual money in 
circulation. The method adopted, that of the gold-exchange 
standard, in operation in India since 1893, in the Philippines 
since 1903, and in Mexico since 1904, involves these features : 

(1) Closing the mints of the country to the free coinage 
of silver. 

(2) Adoption of a fixed ratio of exchange between the 
silver coins in circulation and a gold coin which is made the 
standard of value in all transactions (as the dollar or the 
pound sterling), the money in circulation thus being all or 
nearlj^ all of a fiduciary nature. 

(3) Regulation and limitation of the amount of silver 
money in circulation, so that a fixed parity between it and 
gold may be maintained, (a) by issuing coins in limited num- 
ber and only on governmental account ; (b) by the sale, at a 
fixed rate, of foreign exchange bills payable abroad in the 
standard unit, the money paid for the bills being withheld in 
a special reserve, thus reducing the total volume of money 
in circulation; (c) by the purchase of foreign bills of ex- 
change at a fixed rate, thus paying out and putting again 
into circulation some of the fiduciary money in the special re- 
serve. 

These monetary changes furnish numerous illustrations and 
demonstrations of the quantity theory of money as applied 
to the entire circulating medium of the country.^ The silver 

5 See "Modern Currency Reforms" (1916), by E. W. Kemmerer, pro- 
fessor of Economics and Finance in Princeton University, for a detailed 



48 MONEY AND PRICES [Pt. I 

coins which alone are in actual circulation become fiduciary 
by reason of the artificial limitation of their number, and 
their monetary value is made to conform to the vailue of gold^ 
as used in international trade. 

§ 10. Nature of governmental paper money. The prob- 
lem of seigniorage presents itself in its most extreme form 
when money is made of paper. Paper money is issued either 
by a government or by a bank. We will consider govern- 
mental notes here, reserving until later the ease of bank notes. 
The issue of paper money in some cases grew out of the 
practice of debasing metal. However this may have been, 
governmental paper money may be looked upon as money for 
which a seigniorage of 100 per cent is charged. The gain of 
seigniorage from paper money is greater and is just as easily 
secured as that from coinage of metals. Governmental paper 
money is called ' ' political money, ' ' in contrast to commodity 
money. However, all coins that contain an element of seign- 
iorage, or monopoly value, are to that degree "political 
money." The typical paper money is irredeemable; that is, 
it cannot be turned into bullion money on demand. It is 
simply put into circulation, usually with the " legal -tender " 
quality. Money has the legal tender quality (as the term is 
used in the United States) when, according to law, it must be 
accepted by citizens as a legal discharge for debts due them, 
unless otherwise provided in the contract. The prime pur- 
pose of making money legal tender is to reduce the danger of 
dispute as to payments; but another purpose often has been 
to force people to use a depreciated money whether they would 
or not. The purpose of the issue of political money is usually 
to gain the profit of seigniorage for the public treasury, and 
often it has been the desperate expedient of nearly bank- 
treatment of this remarkable series of monetary changes, probably un- 
equaled in instructiveness to the student of monetary theory. 

6 That is, it is made to conform as closely as do the values of 
gold in two different countries, fluctuating within the upper and lower 
limits of the gold-shipping points, as explained more fully under inter- 
national trade in ch. 15. § 10. 



Ch. 4] FIDUCIARY MONEY, ]\IETAL AND PAPER 49 

rupt governments. Governmental paper money differs from 
bank-notes in that its value does not necessarily depend on the 
promi-^^e of redemption by the issuer. It differs from prom- 
issory notes and bonds in that its value is not based on the in- 
terest it yields, but mainlj^ on its monetarj^ uses. The issue 
of paper money may save the government the payment of in- 
terest on an equal amount of bonds. The promise to receive 
paper in paj^ment for taxes or for public ilands may help to 
maintain its value by reducing its quantity, but nothing short 
of its prompt redemption in standard coins makes it truly re- 
deemable. 

§ 11. Irredeemable paper money in America. The most 
notable examples of paper money in the eighteenth centurj^ 
were the American colonial currencies, the continental notes, 
and the French assignats. In all the American colonies be- 
fore the Revolution, notes or bills of credit were issued which 
were in most cases legal tender. Parliament forbade the 
issues, but to no effect. "Without exception they were issued 
in large amounts, and without exception they depreciated. 
The continental notes were issued by the Continental Congress 
in the first year of the war (1775), and for the next five 
years. The object at first was to anticipate taxes, and it was 
expected that the states would redeem and destroy the notes; 
but this was not done. The notes passed at par for a time, 
but depreciated rapidly as their number increased. It has 
been estimated that the country had less than $10,000,000 of 
coin before the war, and when, in 1780, more than 
$200,000,000 of notes were in circulation they were completely 
discredited: hence the phrase "not worth ^a continental." 
Specie then quickly came back into use. 

The United States, under the Constitution, did not try 
legal-tender paper money till 1862, when paper notes (called 
greenbacks, because of the color of ink with which the re- 
verse side was printed) were first issued, later increased to 
a total of about $450,000,000. Other interest-bearing notes 
were issued with the legal -tender quality and circulated as 



50 MONEY AND PEICES [Pt. I 

money to some extent. Greenbacks depreciated in terms of 
gold, and gold rose in price in terms of greenbacks until, in 
June, 1864, it sold at 280 a hundred. Fourteen years elapsed 
after the war before these notes rose to par in terms of gold 
(in December, 1878), and they became legally redeemable in 
gold January 1, 1879. This was called the ''resumption of 
specie paj^ments." Ever since that time the United States 
has maintained the gold standard. 

§ 12. Irredeemable paper money in Europe. The leaders 
of the French Kevolution, failing to learn the lesson of the 
American revolutionary experience, issued, on the security of 
land, notes called assignats in such enormous quantities that 
they became worth no more than the paper on which they were 
printed. The paper money issued by the Bank of England 
under the restriction act of 1797-1820 is especially notable 
because it gave rise to the controversy which did much to 
develop the modern theory of the subject. Parliament for- 
bade the Bank of England to redeem its notes in coin because 
the government wished to borrow the coin the bank held. 
The result was the issue of a large amount of bank money 
liot subject to the ordinary rule of redemption on demand. 
It was virtually governmental paper money. The notes de- 
preciated and drove gold out of circulation, and it was not 
until 1821 that specie payments were definitely resumed. 
Essentially the method of the restriction act was applied by 
each of the belligerent nations to its state bank in the period 
of the World "War. 

Almost every nation has at some time issued political 
money. During the Franco-Prussian War in 1870, France, 
through the medium of its great state bank, made forced issues 
of notes of a political nature, which only slightly depreciated. 
Many countries — ^Russia, Austria, Portugal, Italy, and most 
of the South and Central American republics — have had or 
still have depreciated paper currencies. 

At once, at the outbreak of the Great War in 1914, the gov- 
ernments of the warring nations began to exercise a strict 



Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 51 

control over the issue of paper money, sought in every way 
possible to gather into the public treasury all the precious 
metals in the form of coins or ornaments, and to give paper 
(either governmental notes or bank-notes) a forced circula- 
tion, making it the sole circulating medium. In such cases 
the money partakes somewhat of the characters both of bank- 
notes and of political money. Even in Great Britain the 
paper money (mostlj^ notes of the Bank of England) depre- 
ciated 20 per cent or more, compared with gold; in France 
and in Belgium, at the worst, nearly 60 per cent; whereas 
in many of the other continental countries (notably Germany 
and Austria) it fell nearly 99 per cent. In Russia the paper 
seems to have become quite worthless. The return to the 
gold standard is one of the most difficult tasks these countries 
have to perform. 

§ 13. Theories of political money. There are two extreme 
views regarding the nature of paper money, and a third which 
endeavors to find the truth between these two. First is that 
of the cost-of-production theorists, who declare that govern- 
ment is powerless to influence value or to impart value to 
paper by law. They deny that there is any other basis for 
the value of money than the cost of the material that is in it. 
Money made of paper, on a printing-press, has a cost almost 
negligibly small, and therefore, they say, it can have no value. 
The facts that it does circulate and that it is treated as if it 
had value are explained by the cost-of-production theorists as 
follows: while the paper note is a mere promise to pay, with 
ho value in itself, it is accepted because of the hope of its re- 
demption, just as is any private note. Depreciation, accord- 
ing to this view, is due to loss of confidence; the rise toward 
par measures the hope of repayment. 

Taking a very different view, the extreme fiat theorists as- 
sert that the government has unlimited power to maintain the 
value of paper money by conferring upon it the legal-tender 
quality. The meaning of fiat is "let there be," and the fiat- 
money advocates believe that the government has but to say, 



52 MONEY AND PRICES [Pt. I 

"Let it be money" to impart value to a piece of paper. 
The typical fiat-money advocates in the United States were the 
' ' Greenbackers, ' ' who wished to retain the greenbacks issued 
in the Civil War and to increase the amount greatly. They 
saw in paper money an unlimited source of income to the 
government. They proposed the payment of the national 
debt, the support of the government without taxes, and the 
loan of money without interest to citizens. All might live in 
luxury if the extreme fiat-money theorists could realize their 
dream. The depreciation that has taken place in nearly 
every case where government notes have been issued, the fiat 
theorists declare to be due to a mild enforcement of the law of 
legal tender. To them the fact that paper money may cir- 
culate for a time at par appears a reason why it always 
should. They do not recognize that there is a saturation 
point in the use of money. 

The almost universally accepted opinion among economists 
rejects both of these views, while recognizing in each a cer- 
tain limited aspect of the truth. The cost-of -production view 
overlooks the features in which paper money differs from or- 
dinary credit paper. The value of a man's promises to pay 
depends on his reputation and his resources ; the resources con- 
stitute the basis of value. Bonds have value because they 
yield interest and are payable at a definite time in standard 
money. But paper money, lacking this basis for its value, 
has another basis in its money use, in its power to buy goods. 

§ 14. Political money; theory and practice. The theory 
of paper money here outlined explains the value of paper 
money as a special case of political monopoly. As the power 
of any private monopoly over price is relative, not absolute, 
so is that of the government over the value of political 
money. The money use is the source of value of the paper 
notes. It is this that gives the economic condition for value 
in paper money and strictly limits the power of the govern- 
ment — a fact overlooked by the fiat theorists. Business con- 
ditions remaining unchanged, the limit of possible issue with- 



Cil. 4] FIDI'CIAUY MONEY, METAL AND PAPER 53 

out depreciation is the number of units in circulation before 
the paper mone}- was issued, the saturation point of full- 
weight and full-value coins. Under wise and honest con- 
trol and regulation, political paper money might serve the 
monetary function very effectively. Since the end of the 
World War, from various quarters has been advanced the 
plan of an international paper money, to be issued by some 
organization like a world federal reserve bank. The amount 
and value of the notes would be regulated in conformity with 
the gold standard. To monetary students this plan is not 
new and is theoretically sound except for the political difficul- 
ties likely to arise. 

Resorted to in desperate extremities, political money has 
usually proved to be a costly experiment. Once the issue of 
political money begins to be expessive, its further limitation 
proves to be most difficult. A result usually unintended is 
the derangement of business and of the existing distribution 
of incomes. The rapid and unpredictable changes in prices 
give opportunity for speculative profits, but injure legitimate 
business. This incidental effect on debts and industry offers 
the main motive to some citizens for advocating the issue of 
paper money. It is peculiarly liable to be the subject of 
political intrigue and of popular misunderstanding. It is 
this danger, more than anything else, that makes political 
money in general a poor kind of money. 

Refebences. 

Jevons, W. 8., Money and the mechanism of exchange. N. Y. Ap- 

pleton. 1875. Chs. VIII, XVII, XVIII. 
Johnson, J. P., Money and currency. Bost. Ginn. 1905. Cha. 

XIII-XVI. 
Kemmerer, E. W., Modern currency reforms. N. Y. Macmillan. 

1916. P. 541. 
Phillips, C. A. N. Y. Macmillan. 1916. Chs. IV, V, XII. 
United States Director of th^ Mint, Annual reports. 
Walker, F. A., Money. N. Y. Holt. Chs. VIII-XII. 
Whdte, Horace, Money and banking illustrated by American History. 

Bost. Ginn & Co. 1914. Bk. II. chs. III-VI. 



CHAPTER 5 



PRICE LEVELS AND THE GOLD STANDARD 

§ 1. Concept of the general price level. § 2. Index numbers. § 3. 
Definition of the standard of deferred payments. § 4. Increasing im- 
portance of the standard. § 5. Defectiveness of the gold standard. 
§ 6. Relative values of gold and silver. § 7. Gold production, 
1800-1850. § 8. Gold production and price changes, 1850-1873. § 9. 
The great fall of prices, 1873-1896. § 10. Nature and object of bimetal- 
ism. § 11. The free-silver movement. 

§ 1. Concept of the general price level. The price of any 
good is some other good or group of goods given for it in 
trade.^ The standard unit of money coming to be the most 
convenient expression for price (whether or not money be 
actually passed from hand to hand in any particular trade), 
prices usually are monetary prices, and more specifically are 
prices in gold, or in silver, or in whatever constitutes the 
standard money unit. But the price of each good is a definite, 
separate fact, which expresses the ratio at which that com- 
modity is sold. The price of any particular kind of goods 
may fluctuate in either direction as compared with the prices 
of other goods at the same time. For example, iron and 
many other goods may rise while wheat and many other goods 
fall in price. There is, therefore, no such thing as an actual 
general change in the prices of goods in terms of money, 
but it may be seen that the prices of large classes of goods, 
often of nearly all goods, change upward or downward at 
the same time and in the same general direction. "We thus 
have need to distinguish between changes in the valuations 
of particular kinds of goods in terms of each other and gen- 

1 See Vol. I, p. 45 S. 

54 



Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 55 

eral changes in the valuation of a number of different goods 
in terms of the monetary unit. 

To get some idea of whether such a general trend occurs, 
the algebraic sum of all the changes in the particular prices 
of a selected group of goods may be taken, and for conven- 
ience this may be reduced to an average price (by dividing 
the sum by the number of articles). Such an average is 
called a general price, and, when comparing it with the gen- 
eral price of another time, we speak of changes up or down 
in general prices, or in the general scale of prices, or in the 
pri<ie level. 

When gold is the standard unit, its value is the converse of 
general prices; as prices go up the value of gold goes down, 
and gold is said to depreciate. As prices go down the value 
of gold goes up, and gold is said to appreciate. Rising prices 
mean falling value of gold (and at the same time falling pur- 
chasing power), and vice versa. 

§ 2. Index numbers. The process of calculating general 
prices and changes in them has in it, inevitably, something of 
arbitrariness and incompleteness. For not all prices can be 
included, but only those of articles of somewhat standardi^ied 
grades and those that are pretty regularly sold in markets 
where prices are publicly quoted. No list of articles that can 
be selected is of equal importance to different persons and 
classes of persons, at different places, at different times, and 
for different purposes. And yet the study of general prices 
as shown by any broadly selected list reveals changes that in 
some measure affect the interests of every member of the 
community. 

General prices are conveniently compared from one time to 
another through the use of index numbers. An index numier 
of any article is the per cent that its price at any certain 
date is of its price at another date (or of the average for a 
series of prices) taken as a base or standard. Thus if the 
average price of cotton in the base year were 10 cents (taken 
as 100) and the price rose to 12 cents, the index number would 



56 



MONEY AND PRICES 



[Pt. I 




Fig. 1. Index Numbers of Prices. The four series of prices here 
shown begin at different periods: the American in 1840 (Aldrich re- 
port 1840-1889 and Bureau of Labor from 1890 on) ; the English in 
1846; the German in 1851; the French in 1857. We have adjusted 
each of these series to a base of tlie average prices for 1890-1899, in 
accord with the basic period used by the American Bureau of Labor. 

The reader must be on his guard against misunderstanding the dia- 
grami. It does not represent the heights of any particulari prices of the 
different countries compared with each other either at any one date 
or for the entire period. Tlie average prices of selected groups of com- 
modities are compared every year with the average of the prices for 
1890-1899 in each country, respectively. The important facts to observe 
are the fluctuations, both their times and their directions, both the 
larger tidal movements and the lesser wave-like movements within the 
business cycles. The figure indicates that both American and German 
average prices have risen somewhat, as compared with the English and 
French prices, since the period before 1860. 

This figure should be studied in connection with that on gold pro- 
duction. The figures indicate that the rapidly growing monetary use 
of gold offset a large part of the effects of increasing gold production 
between 1840-1860 and 1884-1914. Between 1884 and 1896 prices actu- 
ally continued to fall after gold production had begun to climb. Like- 
wise the growing monetary use of gold accentuated strongly the effects 
between 1873 and 1883 of a comparatively small decrease in gold pro- 
duction. 



Cir. 5] PRICE LEVELS AND THE GOLD STANDARD 57 

be 120. A tabular index number is the p^r cent that the 
price of a selected group of articles at any certain date is of 
the price of the same group of articles at a date that has 
been taken as the base. Numerous tabular index numbers 
have been worked out for different countries and periods. 

A chart of the principal index numbers of the leading coun- 
tries is shown in Figure 1. The fact that from 1862 to 
1879 inclusive prices in the United States were expressed in 
an irredeemable paper standard makes comparisons for that 
period misleading. A better idea is obtained by using as the 
base for each of the several series the average of prices in 
each country for the years 1890 to 1899. 

§ 3. Definition of the standard of deferred payments. 
As a medium of exchange, money comes to be the unit in 
which most prices are expressed and compared ; in other words, 
it becomes the common denominator of prices.^ This makes 
it also the most convenient unit in which to express the 
amount of credit transactions and of existing debts.^ A 
credit transaction is a trade lengthened in time; one party 
fulfils his part of the contract by delivering the goods or 
money, the other party promises to give an equivalent at a 
later date. The equivalent may be in any kind of goods; 
for example, in barter one may part with a horse on the prom- 
ise of a cow to be received later; or a small horse on the 
promise of a large one ; or a flock of sheep on the promise of 
its return at the end of the 3'ear with a part of the increase 
of the flock. A simple standard in which to express the debt 
is the thing borrowed, as horse, sheep, wheat, house. Again, 
the thing to which the value of debts is referred may be a 
thing quite different from the goods borrowed, and, with the 
growth of the monetary economy and the use of the interest 
contract, money comes more and more to be used as the 
standard. At length the law declares that in the absence of 
any other agreement, the amount of a debt is to be payable 

2 See VoL I, p. 262. 

3 See VoL I, p. 263, on credit transactions, and p. 302, on interest 
contract. 



58 MONEY AND PRICES [Pt. I 

in terms of the unit of standard money, which thus is made 
legal tender as well as the customary standard of deferred 
payments. A standard of deferred payments is the thing 
of value in which, by the law or by contract, the amount of 
a debt is expressed and payable. 

§ 4. Increasing' importance of the standard. Until the 
use of money develops, the use of credit is difficult and 
limited; it becomes easy when the value of all things is ex- 
pressed in terms of a common circulating medium. It there- 
fore generally is true that the importance of money as the 
standard of deferred payments increases with the use of 
money as a medium of trade. The volume of outstanding 
debts expressed in terms of money now very greatly exceeds 
the total value of the circulating medium. Changes in the 
general level of prices have, therefore, great effect upon all 
existing debts. The value of all debts changes in the same 
proportion as does that of the standard unit of money ; when 
this rises or falls in value, it means increase or reduction, in 
the same ratio, of the purchasing power of every creditor. It 
is as if he had in his possession metal dollars equal in amount 
to the face of the debt, and they had changed by so much 
in purchasing power. The debtor's interests in such changes 
are, of course, just the reverse of the creditor's interests. 

Outstanding contract debts may be roughly divided into 
two classes: short-time loans, running less than a year; and 
long-time loans, running for a year or more.* Fluctuations 
are rarely rapid and great enough to affect appreciably the 
debtors and creditors in the case of short-time loans. The 
results are appreciable in the case of loans running from 
one to five years, and may be very great in the case of loans 
made for still longer periods, such as the bonded indebtedness 
of nations, states, municipalities, and business corporations, 
and as mortgages given by farmers on their land or by owners 
of city real estate. A multitude of interests are thus affected 
by a change in the value of money. When money rises in 

4 See Vol. I, p. 304. 



Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 59 

purchasing power, receivers of fixed incomes are gainers. 
When it falls in purchasing power, they lose. Receivers of 
fixed incomes from loans include not merely private investors, 
but also many educational and charitable institutions which 
dispense their incomes for public purposes. Wages and 
salaries of many kinds go up and down less rapidly than do 
other prices, and thus to some extent wage-earners are in the 
position of passive capitalists ^ as regards changes in the 
monetary standard. In a capitalistic age, therefore, almost 
every individual is affected in some way by a change in the 
value of money. 

§ 5. Defectiveness of the gold standard. Money is, in 
general, for both borrowers and lenders the most convenient 
standard of deferred payments. But from the usage of speak- 
ing of all things in terms of gold arises the popular notion 
that the value of gold is always the same, while the value 
of other things changes. In truth, a fixed objective standard 
of value is not possible of attainment. Although the value 
of gold is stable as compared with most things, it rests on the 
estimates made by men and is constantly changing with con- 
ditions. The current new supplies of gold are comparatively 
regular. For centuries at a time there was little change in 
the methods of mining gold and there were no radical changes 
in its output. The nature of the use of gold, likewise, is 
such as to make changes in the amount of it needed, under 
ordinary conditions, more stable than is that of most other 
goods. Moreover, the stock of gold in monetary uses is but 
slowly worn out; it is, therefore, a large reservoir into 
which flows a comparatively small stream of annual produc- 
tion ; the existing stock is twenty or thirty times the annual 
output. The existing stock of precious metals, gold and 
silver, more than other products of mine and field, is at any 
time the accumulation of many years' production, and is 
changed very little, proportionally, by a large change of out- 
put in any year or short period. It changes in volume as does 

5 See Vol. I, p. 319. 



60 MONEY AND PRICES [Pt. T 

a glacier fed by the snows of many years, not as does a 
river, fiFed by a single rainfall. 

Yet the value of gold expressed in other things is never 
qinte stable, and sometimes several influences combine to 
affect it greatly. At various times the discovery of gold 
deposits, and recently the invention of chemical and mechani- 
cal processes, have suddenly altered the conditions of gold 
production, causing revolutionary results in the field of prices 
and deferred payments. A brief survey of these changes 
will be helpful to an understanding of the problem in- 
volved. 

§ 6. Relative values of gold and silver. Both gold and 
silver were used as moneys in Greece and Rome, and con- 
tinued to be used in Europe in the Middle Ages, though silver 
was much the more common. The two metals continued in 
the seventeenth and eighteenth centuries to be used side by 
side in Europe and in the new settlements in America, silver 
for the smaller and gold for many of the larger transactions. 
Both were legal forms of money in units of specified weights 
and fineness, the weights bearing a certain ratio to each other. 
Thus it was possible for a debtor to discharge his obligations 
with that one of the two metals which at the moment was the 
cheaper at the legal ratio. Fluctuations in the prices of gold 

Fig. 2. Gold Producttotvt of the World, 1493-1914. 
The changes in gold production here shown have bearings not only 
upon problems of money, but in some respects upon nearly every mod- 
ern economic problem. Compare in the present connection this figure 
with Figure 1 in this Chapter showing changes in index numbers of 
prices. 



GOLD PRODUCTION OF THE WORLD. 
1493-1710 

AVERAGES FOB PEBIODSBETOfiE 1870 

... I ... . 
• . . 1600 .... 




Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 61 

in terms of silver were at times such as to cause a large part 

of the full-weight coins of one or the other metal to leave 

circulation (in accordance 

with Gresham's law). So 

from time to time the ratio 

was slightly changed by law 

in the various countries to 

permit the circulation or to 

bring back the kind of money 

that had been undervalued in 

terms of the other. 



Table — Gold production of the 
World. By decades and years, in 
$1,000,000 coinage value 

1890 

1900 

1910 

1911 

1912 

1913 

1914 

1915 

1916 

1917 

1918 

1919 

1920 




62 MONEY AND PEIGES [Pt. I 

It is a remarkable fact that from tlie time of Xenophon 
until the discovery of America (a period of nearly two thou- 
sand years) the market ratio of silver to gold bullion in 
Europe had remained pretty close to ten to one, being only 
temporarily altered by sudden and unusual occurrences. 
From 1492 to 1660 the ratio changed to fifteen to one, where 
it remained with remarkable stability until about the year 
1800. At the establishment of the mint of the United States 
in 1792 that ratio was found to exist. Men had come to look 
upon the ratio of fifteen to one as the natural order, deter- 
mined (it was sometimes said) providentially by the deposit 
of the two metals in due proportion in the earth's surface. 
But, as we now see it, this in part was mere chance and in part 
was due to the equalizing effect of the wide use of both metals, 
so that the one could be easily substituted for the other in 
case of a divergence of the market ratio from the legal ratio 
as money. From the year 1500 until 1800 the western hemi- 
sphere was the main source of the precious metals, the allu- 
vial deposits were widely scattered, were gradually discovered, 
were usually found in small quantities, and were extracted in 
primitive ways. For a short time after the discovery of 
America (from 1493 to about 1544) the average coining 
value ^ of the world's production of gold, nearly all found 
in America, was about one and one-half times as great as that 
of silver ; but thereafter for three centuries from about 1545, 
the annual value of silver produced was between one and 
one-half to four times as great as that of gold, averaging 
about twice as great. Silver was the money chiefly in use 
in the ordinary transactions in all of the principal countries 
of the world. 

§ 7. Gold production, 1800-1850. The legal ratio of 
15 to 1 in the United States, at which by the law of 

6 The amount of silver is here expressed at its coining value; this 
is not the commercial value, hut rather the number of silver dollars 
371.25 fine grains weight that could be made out of the silver produced. 
Silver and gold of equal coining value are, therefore, as to weight al- 
ways in ratio of 16 to 1. 



Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 63 

1792 both metals were to be freely coined at the mint, proved 
to be an undervaluation of gold. The market ratio of the 
two metals had been gradually changing before 1792, and 
continued to change, gold becoming more valuable in terms 
of silver. Gold largely left circulation, and by 1818 silver 
and bank-notes formed nearly the whole of the circulating 
medium. Then the production of gold began to increase ab- 
solutely and relatively somewhat more than that of silver, 
and when the market ratio had become about ISVo to 1 
in 1834, the legal ratio of the United States was changed to 
16 to 1. This overvalued gold and brought a good deal of 
it back into circulation, gradually driving out most of the 
silver (the heavier coins disappearing first). 

In the decade 1841-50 the average annual value of the 
gold production, for the first time since the early sixteenth 
century, exceeded that of silver. Then, from 1848 to 1850, 
came the great gold discoveries in California and in Australia. 
The value of gold produced in the world in 1851 was one and 
one half times that of silver, in 1852 three times, and in 1853 
four times as great ; and then slowly declined, but continued 
every year as late as 1870 to more than twice as great. Let 
us observe the effect on prices that was brought about by 
the discoveries of 1848-49. 

§ 8. Gold production and price changes, 1850-1873. 
The unprecedented increase in gold production between 1849 
and 1853, and the continuance of production in volume about 
fourfold as great as that of the decade 1840-49, caused the 
displacement of silvo-* by gold in the United States and 
drove out a large proportion of the silver coins of smaller 
denominations. To make possible their retention the law of 
1853 was passed, authorizing subsidiary coinage (on gov- 
ernment account only) of lighter weight.'^ Gold became then 
the one standard money actualh^ in circulation in the United 
States, and the increased gold production was reflected at 
once in a rise of prices. This was the most revolutionary 

7 See ch. 4, § 4. 



64 MONEY AND PRICES [Pt. I 

price change that had occurred since the sixteenth century. 
A period of prosperity in business culminated in the crisis 
of 1857, felt more or less in all the leading countries. This 
prosperity accelerated the effect of increasing quantities of 
the standard money. Credit Was stimulated and the rate of j 
circulation and the efficiency of money were increased. 
Prices rose to a temporary maximum in 1857, and then fell, 
as a great international financial crisis occurred. 

Then the substitution of gold for silver in monetary uses 
made an additional market for gold, and at the same time the 
rapid growth of population, commerce, and industry in 
Europe and America began to take up ("absorb") the new 
supplies of gold. The price movements in the United States 
between 1860 and 1879 are passed over here, for the excessive 
issues of greenbacks drove gold out of circulation and made 
greenbacks the standard money (except in California and 
elsewhere on the Pacific Coast, where, by public opinion, gold 
was retained as the circulating medium). In the European 
countries prices in terms of gold, though fluctuating some- 
what, kept at about the same level from 1860 to 1870. The 
years 1871 and 1872 were very prosperous and showed rapidly 
rising prices, which reached a maximum in 1873, when a 
financial panic occurred. 

§ 9. The grreat fall of prices, 1873-1896. In the year, 1873, 
notable in monetary history, just as the gold production for 
the first time since 1851 had fallen below $100,000,000, several 
notable changes in monetary legislation were effected which 
made gold more important in the circulation of a number of 
countries. In 1873 Germany made gold the standard through- 
out the new German Empire (having prepared the way by 
legislation in 1871 which made gold a legal tender alongside 
of silver), and provided that silver was thenceforth to be used 
only in the subsidiary coinage. The same year Belgium, and 
the next year the other countries of the Latin Union (France, 
Switzerland, and Italy) took steps that resulted in demonetiz- 



Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 65 

insr silver, that is, in limiting its coinage to governmental ac- 
count, and in making gold their one standard money. 

In the United States at that time, and until 1879, green- 
backs were standard money, and neither gold nor silver was 
regularly in circulation (except in California). There was 
a long-continued discussion of a "return to specie payments," 
which meant the return to a metallic standard, and the re- 
demption of greenbacks on demand. Meantime in 1873 a law 
was passed making the gold dollar "the unit of value" and 
dropping out the standard silver dollar from the list of coins 
authorized to be issued at the mint.^ From 1873 until 1879 
prices (in greenbacks) were falling in this country very rap- 
idly because the country^, with the increase in population, 
wealth, and business, was "growing up to" its unchanging 
currency supply. For a like reason, at the same time gold 
prices throughout the world were falling. "While this coun- 
try was lowering its level of prices from an inflated paper 
money to a gold commodity basis, the gold basis itself was 
sinking to a lower level.^ Between 1864 and 1876 our own 
gold product had been nearly all exported; but, beginning 
in 1878 and continuing till 1888, the demand of our Treasury 
and banks for gold caused the retention of our own gold 
product in this country (nearly $400,000,000 worth, coining 
value, in the period of eleven years), and required an enor- 
mous net imj)ortation, amounting (in the same period) to 
$225,000,000 worth of gold. The combined effect of these 
causes is seen in the great fall of prices in all gold-standard 
countries in the period of 1873-1896. 

The general price level fluctuated but on the whole tended 
downward between 1884 and 1893 (the year of panic), and 

8 This chancre was what later was referred to in political disrnssions 
as "the crime of '73." The dollar referred to was the standard silver 
dollar; at the same time the coinaf^e of a trade dollar was authorized 
(intended to be used only in foreifrn trade), which, after 1876, was not 
legal tender in the United States. 

7See ch. 4, § 4. 



66 MONEY AND PRICES [Pt. I 

reached a minimu^in in the year 1895 in Germany, 1896 in 
England, and 1897 in America. The resulting increase in the 
burden of outstanding debts was felt by all debtors, but 
particularly by great numbers of the agricultural classes both 
in Europe and in America. Their tribulations were aggra- 
vated by the fact that at that time (especially from about 
1873 to 1896) the prices of their products were falling much 
more rapidly than were general prices, as a result of the 
very rapid extension of the agricultural land supply .^° There 
was complaint, agitation, and demand for relief on the part 
of many interests in France, Germany, England, and the 
United States. As a result, the money question became in 
this country a leading politicail issue and continued to be 
such between 1873 and 1900. 

§ 10. Nature and object of bimetallism. First came the 
"greenback movement," which lasted until after 1880.^^ This 
then gave way to an agitation for bimetallism. Bimetallism 
is the plan of using two metals as standard moneys. Bimet- 
allism is legally authorized when both metals are admitted to 
the mints for free coinage at an established ratio of weight. 
Bimetallism may be legally authorized, but not actually work- 
ing; for if the market value long continues to vary appre- 
ciably from the legal ratio, only one of the metals may in fact 
be left in circulation. This situation is called limping bimet- 
allism (or halting double standard), though this is a contra- 
diction of terms. National bimetallism is confined to a single 
country, as was the case in the United States before the Civil 
War, and in France before 1867. International bimetallism is 
that resulting from an agreement among several nations to 
use two metals on the same terms. 

The theory of bimetallism is that the government can act 
on the value of the two metals through the principle of substi- 
tution. The metal tending to become dearer will not be 

10 See Vol. I, on agricultural leases, p. 159, wheat prices, p. 436, and 
changes in the land supply, p. 442. 

11 See ch. 4, § 13. 



Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 67 

coined, the other will be coined in greater quantities. The 
degree of influence that can thus be exerted on the value of 
the two metals depends on the size of the reservoir of the 
metal that is rising in value. When it all leaves circulation, 
the law on the statute book permitting it to be coined becomes 
a mere phrase. In such a case there is bimetallism de jure, 
but monometallism de facto. The greater the league of states, 
the greater is the likelihood that the plan will continue to 
work. The only notable historical instance of international 
bimetallism is that of the Latin Union which united France, 
Belgium, Italy, and Switzerland in an agreement remain- 
ing actually in force from 1866 to 1874. A strong movement 
developed between 1878 and 1892 in favor of forming a great 
international bimetallic union of states. 

One object of bimetallism was to put an end to the great 
fluctuations in the rates of exchange of money between the 
silver-using and gold-using countries, fluctuations that occa- 
sioned much uncertainty and loss to individuals engaged in 
foreign trade. The rise in the price of gold exchange in 
the silver-using countries (notably India) meant ailso an in- 
crease in their burden of taxation. These countries collected 
their revenues in silver, but thej' had to pay their debts, 
principal and interest, in gold. Another object of this move- 
ment was to prevent the burden of individual debts from 
increasing by reason of the rise in the value of the single 
standard, gold. It was, indeed, hoped that by bringing silver 
much more into use the value of gold would be reduced, thus 
bringing relief to the debtor classes. Still another object of 
the bimetallic movement was to aid the silver-miners and 
silver-producing districts by creating a larger market for 
silver. 

Several international conferences were held, which were 
taken part in by some of the leading financiers of the world, 
representing their respective governments. The United States 
was foremost in advocating the policy ; France at first favored 
it, as did in large measure the British Indian administration ; 



68 MONEY AND PRICES [Pt. I. 

tliougli England was in the main opposed. The movement 
came to nothing. 

§ 11. The free-silver movement. When all hope of inter- 
national bimetallism failed, the efforts of many of its advo- 
cates were turned to the plan of legalizing national bimet- 
allism in the United States at a ratio of 16 to 1. This was 
very different from the market ratio. Gold had become be- 
fore 1860, in fact, the standard of onr money system, and 
after 1873 it was the only metal admitted to free coinage. 
Silver, little by little, had been losing purchasing power in 
terms nf gold, until from being worth in 1873 one sixteenth 
as much, ounce for ounce, it became in 1896 worth but one 
thirtieth as much as gold. The power of silver to purchase 
general commodities fell much less than the change in its 
ratio to gold would indicate, gold having risen in terms of 
most other goods as well as of silver. However, the ''free- 
silver movement" to open the mints to the free coinage of 
silver at the ratio of 16 to 1, supported by one of the leading 
political parties in the ye&r 1896, threatened a sudden and 
marked cheapening of money. Probably gold would have 
been entirely driven out as money for the time and silver 
would have taken its place as the standard. It is not im- 
possible, however, that the substitution of silver for gold in 
the United States would have brought the two metals to 
parity at a level of prices much less than 100 per cent 
higher than the existing one, possibly not more than 20 or 30 
per cent higher. In any event, ''free silver" would have 
accomplished the purpose of making the standard of deferred 
payments cheaper. It was at first a debtors' movement, but 
to succeed it had to enlist the support of other large classes 
of voters. And thus it developed into the more sweeping 
theory that wages, welfare, and prosperity were favored by 
a larger supply of money quite apart from the effect it would 
have upon debts. 

In its extreme form the free-silver plan was a fiat scheme ; 
for some of its supporters believed that by the mere passage 



Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 69 

of the law the two metals could be made to bear to each 
other any ratio desired. But its most intelligent advocates 
recognized that the force of the law was limited by economic 
conditions. The -victory of the gold standard in the cam- 
paign of 1896 was, it would seem, due more to the well- 
founded fear that a sudden change of the money standard 
would cause a panic than to a popular understanding of 
the question. 

References. 

Anderson, B. M. Jr., Effects of the war on money, credit and banking 
in France and the U. S. Carnegie Endowment for International 
Peace. P. 227. New York. Oxford University Press. 1919. 

Mitchell, W. C, History of prices during the war. P. 95. Wash- 
ington War Industries Board. 1919. 



CHAPTER 6 



RISING PRICES AND THE STANDARD 

§ 1. Eising prices, 1896-1913. § 2. Rising prices in Europe, 1914- 
1920. § 3. Causes of European inflation. § 4. Gold stocks of belliger- 
ents. § 5. Redistribution of European gold stocks. § 6. The flood of 
gold to America, 1915-1917. § 7. The gold embargo in the United 
States. § 8. Gold depreciation and gold production. § 9. The high 
cost of living, 1919-1920. § 10. Various ideal standards suggested. 
§ 11. The tabular or multiple standard. § 12. Fluctuating standard 
and the interest rate. 

§ 1. Rising prices, 1896-1913. The free-silver advocates 
got what they desired, a reversal of the movement of general 
prices, through an occurrence for which no political party 
could justly claim the credit. In 1883 the gold production 
of the world was less than $100,000,000. From that date, 
with the opening of new gold-yielding territory in South 
Africa and in the Klondike, the annual output of gold had 
been increasing rapidly and almost steadily. The methods 
of extracting gold theretofore had stiU been in large part 
of a primitive sort. But intricate machinery was taking 
the place of crude tools, chemical processes had been intro- 
duced (notably the cyanide process), and the principal pro- 
duct began to come from the regular and certain working of 
deep mines rather than from chance surface discoveries. In 
many parts of the world there were enormous deposits of 
low-grade ores, before useless, that could be worked eco- 
nomically by the new methods. It is noteworthy that the 
very year 1896, which marked the height of the political 
agitation to abandon the gold standard for silver, saw the 
gold production for the first time in all history surpass the 
$200,000,000 mark. The gold output had not only caught 

70 



Ch. 6] 



RISING PRICES AND THE STANDARD 



71 



up with, but had beguu to surpass, the normal monetary de- 
mands of the world, meaning b^^ that phrase the amount of 
gold needed to maintain a stationary level of prices. 

A study of Figure 1, chapter 6, will help, to an apprecia- 
tion of the enormous increase in the world's production of 
gold after 1850. The production of gold from the discovery 
of America to 1850 doubtless was much greater than it had 
ever been in any equal period. But this amount was dupli- 
cated in the next quarter of a century, again duplicated in 
the next twenty-five years, and more than doubled in the fol- 
lowing eighteen years. The annual average output in the 357 
years ending 1850 was $8,700,000, in the quarter century fol- 
lowing 1850 was $124,000,000, 
from 1876 to 1900 was $140,000,- 
000, and from 1901-1918 was 
$405,000,000. 

The whole character of the 
monetary problem was changed, 
A period of rising prices set in, as 
is shown graphically in Figure 2, 
chapter 6. By 1913 prices had 
risen just about 50 per cent above 
the low level of 1896. The rise 
was at the average rate of nearly 
3 per cent each year. This caused^ a reversal of the 
former positions of advantage and disadvantage on the 
part of debtor and creditor respectively. The burden 
of the average debt began relatively to decrease. A 
wide field for enterprisers' profits was opened up by the 
rapid displacement of prevailing prices in all quarters of the 
industrial world. The price of manufacturers' products rose 
in advance of the rise of costs of many raw materials and 
especially of the labor costs of manufacture. The average 
enterpriser's gain was the average wage-worker's loss. 
Wages (and salaries), as nearly always in the case of a 
change of price levels, moved more slowlj^ than did the prices 



iu Yl-^US, IQOi -ivia 
7300 MILLiON DOLLARS 


25 YEARS, 1S76-I9O0 




357 YEARS, 1493-1850 
= 25 •• IS51 1875 

5!00 M'.UION DOLLARS 


o 

1 

1 

» 



Fig. 



1. Gold Production 
RY Periods 



T2 MONEY AND PRICES [Pt. I 

of most of the commodities that are bought with wages, 
thus causing great hardship to large classes living on com- 
paratively slowly moving incomes.^ Extremes meet, and these 
classes include both those living on passive investments and 
those dependent on their daily labor for a livelihood, 

§ 2. Rising prices in Europe, 1914-1920. The year 1913, 
the last before the outbreak of the World War, marks a new 



Wholesale Prices leso-isw 

1914- 100 




1 — I I I — I — I — I — I — I — t — I I 1 — p— t — I — I — I— I — I — I — I — I — I — 

1890 1892 1894 1996 1898 1900 1902 1904 1906 1908 1910 1912 1914 

Fig. 2. Wholesale Prices in the U. S., 1890-1914. 

era in price history, and is now usually taken as the base 
from which are measured in the various coufntries the remark- 
able series of price changes that followed. The year 1914 
was one in which the political outlook was disquieting, and 
the European state banks and treasuries were quietly build- 
ing up their gold reserves to meet possible emergencies, thus 

1 This happened to coincide with a relative increase of the prices of 
food-products and of other necessities of daily life at a greater rate than 
general prices. This aspect of the much-discussed rising cost of living 
must be carefully distinguished from that of the change of the general 
price level, and also from that of the relatively slower change of wages. 
See Vol. I, pp. 437, 445-446 on population and food supply. 



Ch. 6] 



RISING PRICES AND THE STANDARD 



73 



contracting the circulation. The annual average index num- 
bers in all the leading countries were nearly the same in 1914 
as in 1913. 

In the warring countries, however, wholesale prices began 
at once in August to rise rapidly, attaining in the last quarter 
of 1914 the figure of 107 in France and 108 in Great Britain. 
Ketail price changes in every countrj^ lagged behind the whole- 
sale, not infrequently being retarded a year or more. This 



260 - 


Wholesale Prices 


1913- 


1921 / \ 


2-»0- 


1914 =100 




T V 


i20 ■ 






/ \ 


200- 






X^^ \ 


180- 




A" 


\ 


leo - 


V 


/ 


v^ 


140- 


/ 






120 - 


y^ 






100 - 


-^K.— ——♦—-'—'-♦->— ' 






80 - 






. 


60 ■ 








40 ■ 








0- 


1 — , 1 , — , — ., 


— I 


■ ■ III" 



1913 1914 



Fig. 3. Wholesale Pkices in the U. S., 1913-1921. 

rise of prices continued, with hardly an interruption, in 
all countries, reaching the maximum about the middle of 
1920. 

In the United States prices fell quickly to 98 in the last 
quarter of 1914, as gold was clamorously (and foolishly) de- 
manded by European bankers, and a brief financial panic 
occurred. But the average of prices continued in the United 
States almost stationary until the last quarter of 1915 (that 



74 



MONEY AND PRICES 



[Pt. I 



is, about one year after the war began in Europe), when 
they began to rise sharply, for reasons that will be indicated 
in the next section. The changes are shown graphically in 
Figures 3 and 4, Chapter 6. 

§ 3. Causes of European inflation. Changes in index, 
numbers reflect changes in the relation of the quantity of 
goods to be exchanged, expressed in their prices, and the 
quantity of money used in exchanging them. Therefore the 
explanation of any particular rise in the price level may be 




1915 I9IC 1917 I9ia 1919 I9Z0 1921 

Fig. 4. Prices in the U. S., 1915-1921. 

found in the factor of goods, (a) in a reduction of their amount 
or (b) a lessened need to exchange them by means of money; 
or may be found in the factor of money, (x) in an increase in 
the amount of money or (y) in an increased use of substitutes 
for money, such as banking credit. At the outbreak of the 
war the popular explanation of rising prices is the lack of 
goods — that is, (a). Attention is drawn dramatically to the 
number of men taken out of industry to go into war service, 



Cir. C] RISING PRICES AND THE STANDARD 75 

at the front or behind the lines. But these comprise only a 
small percentage of the total population; their places are in 
large part taken by women and by older men, inspired by 
patriotic motives, and the exercise of war-time economies 
largely reduces the demand for many kinds of goods. 

Factor (b) doubtless has some validity: withdrawing men 
from ordinary industry, where they receive wages in money 
and spend it in retail purchases, and putting them into the 
army, where their food, clothing, and other wants, are sup- 
plied bj' the government, reduces the monetary demand of 
the community. At the same time, the use by the govern- 
ment, factor (y), of the facilities of the banks in its war 
purchases reduces the field within which money is required 
in war-time as compared with ordinary peace-time business. 

Much the larger part of the explanation sought is to 
be found in (x). Immediately on the outbreak of war all 
the warring countries began to issue paper money, usually 
through the agency of their centrail state banks. They con- 
tinued to issue it in larger and larger amounts not only until 
the armistice in November, 1918, but, under the pressure of 
financial need, after the armistice. Even England and 
France, whose prices were already up to 235 and 330, respec- 
tively, at the armistice (on the basis of 1913 prices), each 
increased their note issues about 130 per cent, between the 
armistice and the middle of 1920. The effect is seen in the 
mounting price curves. Though it is impossible to estimate 
exactly the amount of paper money issued, because of differ- 
ent agencies, governmental and banking, through which it was 
done, the rise in prices probably fell short of the paper money 
inflation; but it must be considered that this was in part 
offset by the complete withdrawal of gold and silver from 
circulation. 

§ 4. Gold stocks of belligerents. The depreciation of the 
paper currency was not due to the absence of gold in these 
countries. They all alike made strenuous efforts to impound 
in their central treasuries all the gold that was in the 



76 MONEY AND PRICES [Pt. I 

countries. A strong patriotic appeal was made to all citizens. 
Some gold that had been in circulation was exchanged for 
paper issued by the banks ; in many cases old coins that had 
been hoarded for generations (as is not uncommon in Europe), 
and therefore having no more effect on prices than so much 
gold in the earth, were brought out of hiding and into the 
banks. Family plate, ornaments, and jewelry were brought 
to the mints, were melted and assayed, the owners not only 
being paid in bank-notes, but receiving certificates of patriotic 
service, and often, besides, some valued privilege, such as 
that of driving a nail into the Hindenburg wooden statue in 
Berlin. This process of getting gold has been called "min- 
ing it out of the pockets of the people." 

The total gold held by all Euiropean banks and state treas- 
uries between 1914 and 1919 increased every year (excepting 
in 1916). Most of this increase took place in the neutral 
countries, notably Spain, Holland, and the Scandinavian 
countries, to which it was shipped to pay for war supplies. 
But France and Italy nearly held their own, and England 
and Germany each largely increased their gold stocks. 
Russia and Austria, however, lost a large part of their gold 
stocks, Russia by export to buy goods under the Bolshevik 
regime, and Austria by forced deposit with Germany as a con- 
dition of financial assistance. 

§ 5. Redistribution of European gold stocks. The net 
gain of gold, expressed in terms of American dollars, in lead- 
ing European banks and central treasuries was approximately 
as follows (not including Russia, the data for which are un- 
certain) : 

Tear ' '' '"' Amount in $1,000,000 

1914 329 gain 

1915 690 gain 

1916 190 loss 

1917 89 gain 

1918 214 gain 

Total (5 years) 1132 net gain 



Ch. 6] RISING PRICES AND THE STANDARD 77 

Classified by groups of countries,^ it appears that in the 
war period the Central Empires gained net about 6 per cent 
(Austria losing nearly all and Germany more than doubling 
its stock), the Allies (England, France, and Italy) gained net 
28 per cent (France and Italy, which had large stock at the 
beginning, losing little, and England, which had a small 
stock, more than trebling), and European neutrals gained net 
66 per cent, of which Spain got $338,000,000, Holland 
$216,000,000, the Scandinavian countries $102,000,000, and 
Switzerland $47,000,000 value. 

It is apparent that the gold that was collected by the 
belligerents did not, as it is often assumed, serve ' ' to support ' ' 
the value of the paper money which had been issued in ex- 
cess. Indeed, it may be said that it did not in the least 
so serve. What it did do was to give to these countries a 
valuable exportable commodity to exchange with neutrals for 
much-needed supplies of goods, and to afford the readiest of 
assets for post-war finlancing. Error will be avoided by 
clearly recognizing that these European stocks of gold had 
ceased to be money for domestic purposes, and .that their 
essential use was to be found only in international trade as 
long as specie payments were suspended. 

§ 6. The flood of gold to America 1915-1917. The United 
States lost some gold to Eu{rope in the first months of the 
war; but thereafter, while it remained neutral, it received 
large quantities of gold from Europe. In the first month of 
the war, August, 1914, and increasingly in the following 
months, contracts for food and supplie? of all kinds were 
placed in America by European countri s, and soon a large 
and steadily swelling stream of exports was moving toward 
Europe. The Central Empires were prevented by the 
Allied blockade from getting many of these goods directly, 

2 These figures are from a different source ; the relatively small dis- 
crepancy in the total does not necessarily indicate an error, but a 
slight difference in the data, or the inclusion of some minor countries 
in the figures. 



78 



MONEY AND PRICES 



[Pt. I 



1000 



900 - 
800 - 
700 - 
600 - 
500 - 
400 - 
300 - 
200 - 
100 - 



Imports of Gold to U.S. 
Exports of Gold from U.S. 




1913 1914 1915 1916 1917 1918 1919 

Fig. 5. Movement of Gold by Years 



1920 



but large amounts got into Germany and Austria through bor- 
dering neutral countries, which profited greatly by this trade. 
As England and France accumulated rapidly large debits 
in America, they not only floated loans of various kinds to 
satisfy these for the time, but also shipped here gold in un- 
precedented amounts. For two years our gold stock had been 
almost unchanging; but between July 1, 1915, and the end 
of June, 1917, the net increase of gold stocks in the United 
States was about one and a quarter billion dollars — a veritable 
''flood of gold" borne upon which prices rapidly rose. 

This inflow continued until after our entry into the war 
(in April, 1917), when our large loans to the Allies reduced 
their need of sending us gold, and at the ^ame time our 
increasing pU|rchases from Spain, South America, and Asiatic 
countries made some net exports of gold necessary, first in May, 
and then after June in increasing amount. The movement of 
gold by years is shown graphically in Figure 5, chapter 6. 

§ 7. The gold embargo in the United States. Moved by 
mistaken fear, the Federal Reserve Board imposed an embargo 






Ch. 6] RISING PRICES AND THE STANDARD 79 

on the export of gold (made its export illegal). This pol- 
icy of gold-fetichism, which remained in force from Septem- 
ber, 1917, to June, 1919, involved a deplorable lapse from 
sound monetary principles. The gold embargo had the evil 
effect of introducing into conditions ailready bad, a new and 
artificial element of inflation. However, trade conditions were 
such that the general world balance of gold payments would, 
on the whole, have been little away from America, otherwise 
the embargo would have been still more difficult to enforce. 
As far as it was enforceable (which it was probably, for the 
time, in large part), the embargo could have only the evil 
effects of disrupting the exchange rates (as it did) with 
countries to which we had international balances, notably 
Argentine, Spain, and Japan. Indeed, in principle, it is 
suspension of specie paj'ments in international trade, and 
this is an abandonment of the international gold standard. 
Our exchanges with a few foreign countries that were selling 
us largely were thrown into disorder. In the twenty-month 
period of the embargo, our net loss of gold was only $5,000,000. 
Just as the embargo was removed these conditions were 
already changing. In the next ten months (June 1, 1919, to 
April 1, 1920) our net exports of gold were more than 
$400,000,000, which served to restore the value of the dollar in 
those countries where it had depreciated. Then, again, after 
a few months of fluctuating balances, began, in September, 
1920, a new flood of gold to the United States, which by the 
end of May, 1921, amounted to more than $480,000,000. The 
exports of gold from the United States between November, 
1918, and August, 1920, have gone largely to Japan, China, 
British India, Hongkong, Spain, Argentine, and Mexico, 
Imports since September, 1920, however, have been largely 
sent by England, France, Sweden, and Canada, not merely to 
pay their trade balances, but because the United States has 
become the most important free gold market in the world, 
and "dollar exchange," the best international currency, is 
eagerly desired by producers and owners of gold every- 
where. 



so 



MONEY AND PRICES 



[Pt. I 



§ 8. • Gold depreciation and gold production. In explana- 
tion of the changes in price levels in the various countries, a 
distinction should be made between gold depreciation and 
paper depreciation — or, otherwise expressed, between gold 
inflation and paper-money inflation. The one expression re- 
fers to the value of gold in terms of goods, the other to paper 
prices expressed in gold. In the United States (except dur- 
ing the embargo, to a slight degree) and several other coun- 
tries gold has continued to be the standard money in in- 
ternational trade, and the rising index number has reflected 
a real fall in the purchasing power of gold. The main 
reasons for this are: (1) the transfer of large amounts of 
gold from the countries where for the time being it has been 

in fact demonetized, to the coun' 
tries still maintaining the gold 
standard; our own gold stock in 
two years increased by the amount 
of the world 's total production for 
three years; (2) the increased 
use of banking credit under the 
Federal Reserve system has en- 
abled an equal amount of gold to 
perform more monetary services; 
and (3) the world's production 
of gold, which reached its highest 
peak in 1915, continued, relative to the narrowed field 
of its monetary uses, to be larger until 1920 than it had 
ever before been in history. This is shown in Figure 6, 
chapter 6. 

Higher prices in terms of gold mean higher wages, higher 
costs for machinery and supplies, in short, higher costs of 
every kind in gold-mining. Many mines formerly profitable 
must be abandoned, one after the other, until the costs of 
mining on the marginal mines are brought into accord with 
the value of the gold produced. The folly, at such a time, 
of proposals for governmental subsidies and bonuses to gold- 




DETAIL- 1908 ON, 
HIGH TIDE 



Fig. 



6. Gold Production 
AT THK Peak 



Ch. 6] RISING PRICES AND THE STANDARD 81 

mining to keep up the quantity of gold ought to be apparent 
to any one with the most elemetary understanding of mone- 
tary principles. Yet such a proposal was presented in a bill 
in Congress, and strongly supported, as it was said, "to 
aid us to maintain the gold standard." 

The increase of index numbers in countries with paper 
currencies is in every' case greater than that in gold-stan- 
dard countries. The diffe!rence measures, pretty exactly, 
reciprocally^ the depreciation of the paper in terms of gold, 
and the abnormal rise of foreign exchange rates. 

§ 9. The high cost of living, 1919-1920. The curve of 
general wholesale prices that began to rise in the United States 
about July, 1915, reached its peak in May, 1920, at a point 
172 per cent above the level maintained from 1913 to June, 
1915. Retail prices (estimated as ''cost of living" on a 
standard family budget) followed on the up-swing, but, as 
usual, lagged behind, reaching a maximum in the middle of 
1920, a little more than 100 per cent above the 1913-15 level. 
A very large part of this increase both of wholesale and of 
retail prices occurred in the post-war period of great specu- 
lation between March, 1919, and May, 1920. This movement 
was world-wide, as the result partly of great increases of 
paper money and bank credits, in the European countries, 
necessary because of the desperate state of their finances, 
and needlessly assisted in America by those having ultimate 
authority in the Federal Reserve system. Prices ran the 
usual course as a financial crisis approached, goods being 
bought and contracts made with borrowed funds in the hope 
of a further rise of prices. It was for many a veritable 
financial joy-ride. 

Such a rapid rise affected different classes of persons in 
business and different classes of goods very unequally. Cases 
of extravagant expenditures (relative to former standards) 
were conspicuous in working class circles, where wages rose 
faster than the cost of living, and among the newly-rich 
employers who had ' * profiteered ' ' in the war and the post-war 



82 



MONEY AND PRICES 



[Pt. I 



period of speculation. Less conspicuously, great numbers of 
wage-earners and salaried and professional workers felt 
keenly and suffered greatly from the higher cost of living 
(popularly denominated the H. C, L.). The different ele- 
ments in the cost of living moved at various rates, as is 
shown in Figure 8, chapter 6. 

Among the industries that profiteered most for the time 
were those engaged in producing clothing, furniture, and food, 
including nearly all agricultural products. Among those that 
were losers in the purchasing power of their incomes were 



PER 

300 



150- 



100 



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--T— +—- r— 
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1916 1917 1918 1919 1920 1921 

Fig. 7. Average W\eekly Earnings 
AND Cost of Living of Factory 
Employees in New York State. 

many active enterprisers whose products rose in price more 
slowly than the average (or than their wage bills and other 
costs) and all public utilities fixed by charter or controlled 
by price-fixing commissions. Many railroads, trolley lines, 
gas and electric companies were brought to the verge of 
bankruptcy or beyond. 

§ 10. Various ideal standards suggested. Price history 
since 1873, however varied, teaches one lesson clearly: that 
our "standard" unit of price has in fact been subject to 
great fluctuations in its value. "We escape the evils of a 



Risixr; PRICES and the standard 



83 



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juur 
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JULY 

1318 



JULY 

1817 



J UNE NOV . MAfl. JUUr tWV. MAR JUiy NOV MAftJUtf 

1918 1918 ISeO 1921 



Fig. 8. Cost of Lia'ixg in the U. S. (By permission of the Na- 
tional Industrial Conference Board.) 

rising standard of deferred payments (falling prices) only to 
meet those of a falling standard (rising prices) . And as long 



84 MONEY AND PRICES [Pt. I 

as we have so fluctuating a standard these difficulties must 
arise again and again, continually repeated, causing unmerited 
gains and undeserved losses to individuals. But what stand- 
ard would be better than that of gold? It may, perhaps, 
be agreed that the ideal standard of deferred payments is 
one that wouil,d insure justice between borrower and lender. 
Yet different views may be and have been taken as to what 
constitutes justice in this matter. The suggestion is attrac- 
tive that repayment should involve the return of enjoyment 
equal to that which could be purchased with the sum at the 
time of the loan. Such a standard is impossible of perfect 
realization in any general way, for men's circumstances are 
constantly changing. To insure even to the average man 
the same amount of enjoyment is only roughly possible. The 
same goods do not afford the same enjoyment when conditions, 
either subjective or objective, have changed. Another sug- 
gestion is that the goods returned should represent the same 
sacrifice as those lent. Here again the difficulty is in the' 
lack of a standard applicable to all men. Whose sacrifice? 
That of the lender, who may be rich, or that of the borrower, 
who may be poor? Some have supposed that the condition 
of equal sacrifices was met by the labor standard, according 
to which the sum returned should purchase the same number 
of days of labor as when borrowed. But what kind of labor 
is to be taken, that of the lender, or that of the borrower, 
or that of some one else ? Labor is of many different qualities, 
which can be exactly compared only through their objective 
value in terms of some one good.^ 

It must be recognized that any possible concrete standard 
of deferred payments will sometimes work hardship in in- 
dividual cases. The best average results for justice and social 
welfare will be secured by measuring debts in some standard 
that will change least often, and least rapidly, in relation 
to the great majority of people of all classes in the community. 

§ 11. The tabular or multiple standard. Gold is the best 

3 See on the labor theory of value, Vol. I, pp. 210, 228-229, 502. 



Ch. 6] RISING PRICES AND THE STANDARD 85 

standard yet devised and put into actual practice, but it is 
very imperfect. A standard better than a single metal, more 
stable than a single commodity, is desirable if it can be found. 
Apart from the difficulties of its practical operation, such a 
standard would be a tabular standard, consisting of a number 
of leading commodities in fixed proportions, such as is used 
in calculating index numbers expressing the general scale of 
prices. This averages the fluctuations of particular goods 
and would give a fair approximation in practice to the ideals 
of equal sacrifice and equal enjoyment (on the average, 
though not in individual cases). While some natural mate- 
rials are growing more scarce and call for more sacrifice, other 
products are by industrial progress becoming more plentiful. 
This kind of standard has been viewed with favor by many 
monetary authorities, and, despite the administrative diffi- 
culties, ways may yet be found for putting it into practice. 

After choosing the components of the multiple standard, 
the actual regulation of the quantity of money to make 
prices conform to the standard might be accomplished in 
one of several ways. It might be done by letting the 
value of the gold dollar fluctuate as it does now, while re- 
quiring a greater or less number of dollars to be given 
in fulfillment of all outstanding contracts. For example, if 
prices by the multiple standard fell from 100 to 95 in 
the time between the origin of a debt of ^100 and its payment, 
the debt would be discharged by paying $95; if prices rose 
to $110, the debt would be discharged only by the payment 
of $110. 

Another plan is that of a "compensated gold dollar." By 
this plan the legal weight of gold coins would be increased 
or decreased from time to time to conform with the changing 
index numbers. Still a third method would be to regulate 
the issue of standard paper money, contracting and expanding 
its amount by issue and redemption, by deposit in and with- 
drawal from depository banks, at regular intervals to bring 
prices into conformity with the tabular standard. These are 



86 MONEY AND PRICES [Pt. I 

as yet but distant possibilities, and for some time to come 
gold will continue to serve as tlie standard money in the 
same manner as in the past. 

§ 12, Fluctuating standard and the interest rate. In 
connection with the standard of deferred payments there is 
presented a problem of the effect that fluctuations of the 
standard may have upon the interest rate.* As the general 
price level falls or rises, the monetary standard conversely 
appreciates or depreciates.^ If these changes are slight in 
amount and imperceptible in their direction they may not 
affect considerably the motives of borrowers and lenders. 
Therefore, the rate of interest this year in long-time loans 
would be just that resulting from the expectation, on all 
hands, of a stationary level of general prices. Suppose that 
rate to be 5 per cent on the standard investment (such as real- 
estate loans and good bonds). Then the lender of $1000 will 
receive each year a $50 income a,nd at the end of the invest- 
ment period $1000 principal, each dollar of which will pur- 
chase the same composite quantum of goods that a dollar 
would have purchased at the time the loan was made. Like- 
wise, the borrower would pay interest and principal in a 
standard that reflected an unchanging general level of prices. 
But, now, if the general level of prices unexpectedly falls 1 
per cent within the year, the creditor of a loan maturing at 
the end of the year would receive (principal and interest) 
$1050, which will purchase 1 per cent more goods per dollar 
than the sum he lent, or (approximately) $1060 worth of 
goods. Hence, he has received, in quantum of goods, a yield 
of 6 per cent on his investment. If this change continues for 

4 This could not be treated in connection with the interest rate in 
Vol. I, Part IV, for the reason that even its elementary treatment must 
presuppose the fuller study of the nature of money and the study of 
changes in the level of prices, that has just been given in this and the 
three preceding chapters. The theory of interest in Vol. I, therefore, is 
a static theory in respect to the standard of deferred payments, and re- 
quires adjustment to apply to a condition of a changing price level. 

5 See ch. 5, § 1. 



ch. g] rising prices and the standard 87 

five years, the lender of a five-year loan would receive each 
year $50, having a purchasing power successively 1, 2, 3, 4, 
and 5 per cent greater than the same sum had at the making 
of the loan ; and at the end of the five years would collect the 
principal, having a purchasing power 5 per cent greater. 
The lender, on his part, would have to pay interest and re- 
pay the principal in a money that is to be obtained only in 
exchange for a larger sum of goods than that which could be 
bought with each dollar that he borrowed. This means that, 
with individual exceptions, creditors generally gain and 
debtors lose by falling prices. 

But this is fully true only in respect to loans already made. 
For, just to the extent that such a movement of prices comes 
to be more or less regularly in the same direction, both bor- 
rowers and lenders are able to take it into account, and, as 
experience shows, do take it into account." When prices 
fall men become more eager to sell wealth, to lend the pro- 
ceeds, and more reluctant to borrow for investment at the 
prevailing rate of interest and at the prevailing prices. 
There is an incentive to divest one's self of ownership (e.g., 
by selling stocks) and to become a lender (e. g., by buying 
bonds). This whole situation is reversed in a period of ris- 
ing prices. The result is that the rate of interest in any long- 
continued period of falling prices (such as from 1873 to 
1896) has a trend downward and in a period of rising prices 
(such as from 1897 to 1915) has a trend upward. This 
movement of readjustment would not go on indefinitely, even 
if the same trend of prices continued ; for in the strict theory 
of the case the adjustment would be complete when the in- 
terest rate had changed by just the amount of the annual 
change in the level of prices. For example, if 5 per cent is 
the static normal rate of interest, then when prices are fall- 
ing 1 per cent each year, the adjusted rate of interest would 
be 4 per cent; and when prices were rising 1 per cent each 

6 Mention was made in Vol. I, of the prospect of profit as aflfecting 
the motives of commercial borrowers; e.g., pp. 298, 335, 348, 495. 



88 MONEY AND PRICES [Pt. I 

year, the adjusted rate of interest would be 6 per cent. Such 
adjustments serve to some extent to neutralize the effects of 
changes in the standard of deferred payments as far as 
concerns new loans made in view of just such a change and in 
expectation of its continuance. But no one can foresee exactly, 
and most persons take little account of, such a change until 
it has continued for several years in the same direction. The 
adjustment is therefore never very prompt or very exact. 
In some years the general level of prices has risen more than 
5 per cent, or more than enough to offset the entire interest 
received by most lenders. The principal and interest com- 
bined have no greater purchasing power at the end of the 
period than the principal alone had at the beginning of it. 
It is the same as if the dollars had been buried during a period 
of stationary prices.'^ 

7 The modern explanation of this phenomenon was worked out in the 
period of falling prices before 1896, and hence was referred to as the 
theory of "appreciation and interest" (meaning the relation of the ap- 
preciating dollar to a falling rate of interest). More generally the 
theory is that of the relation of a changing standard of deferred pay- 
ments and the rate of interest. 

References. 

Bureau of Applied Economics, Changes in the cost of living 1914- 

1919. P. 55. Washington. 1919. 
Fisher, Irving, Appreciation and interest. A. E. Assn., Pubs. 11: 

331-442. 1896. 
Same, Stabilizing the dollar. P. 205. New York. Macmillan. 

1920. 
Jevons, W. S., Money and the mechanism of exchange. N. Y. Ap- 

pleton, 1875. Ch. XXV. 
Johnson, J. F., Money and currency. Bost. Ginn. 1905. Chs. XI, 

XII, xvn. 

Marshall, L. P. and others. Materials for the study of elementary 
economies, Chicago University Press, 1913, 787, 788 (extract 
from Broion, H. G.,) , 788, 789 (extract from Clark, W. E., in 
"How to invest when prices are rising." 1912). 

Noyes, A. D., Forty years of American finance. N. Y. Putnam. 
1909. Chs. I-III. 

Phillips, G. A., Ed., Readings in Money and banking. N. Y. Mac- 
millan. 1879. Chs. VI, VII, XIII. 

Walker, F. A., Money. N. Y. Holt. Chs. Ill, VI, VII. 



PART II 
BANKING AND INSURANCE 



THE FUNCTIONS OF BANKS 



CHAPTER 7 

§ 1. Nature and classes of banks. § 2. Functions of banks. § 3. 
The essential banking function. § 4. Demand deposits. § 5. Discount 
and deposit. § 6. Nature of banking reserves. § 7. Time deposits. 
§ 8. Bills of exchange, domestic. § 9. Issue of notes. § 10. Diver- 
gent views of typical bank-notes. § 11. Banking credit as a medium 
of trade. § 12. Productive services of banks. § 13. Earnings of banks. 

§ 1. Nature and classes of banks. A bank, as one first 
comes to know it, is a building (or a room in some building) 
in which there is a fire- and burglar-proof safe. In this 
room are men receiving and paying out money and acting 
as bookkeepers. Usu[ally, however, the word bank means, 
not the building, but the business organization or the enter- 
prise as a whole. Banks perform a variety of useful func- 
tions in every modern community. All these functions touch 
in some way upon the use of money, and banking problems 
always are related to money problems. It is our purpose 
now to understand the nature and work of banks in relation 
to the general business activity of the community. 

In the United States there were on June 30, 1920, more 
than 30,000 banks reported. These may be classified first 
according to the source from which they derive their charters 
or authority to do a banking business as: national, state, and 
private. The last are unchartered and act under the general 
state laws governing private contracts : in general they are 
unsupervised.^ Banks may be classified also, according to 
the two main types of business they perform, as banks for 

1 Opinion favors prohibiting the use of the word bank to any except 
regularly incorporated organizations, or at least subjecting private 
banks to the same supervision as the chartered banks. 

91 



92 BANKING AND INSURANCE [Pt. II 

savings and commercial banks. Most banks do mainly a gen- 
eral commercial business; some are distinctly banks for sav- 
ings ; but in truth this dividing line can be less and less sharply 
drawn between banks as units; rather the distinction must 
be made between the savings function and the commercial 
discount function, which are more and more being performed 
by one and the same bank. The statistical data collected in 
the United States distinguish only imperfectly between these 
two. The trust company usually unites these two functions 
in large degree. This matter will be better understood in 
connection with the analysis of the functions that banks per- 
form, now to be given.^ 

§ 2. Functions of banks, incidental. Almost every bank 
performs various functions useful to its customers, but some 
of which are not essentially bound up with banking, and 
may be performed by institutions that are not truly banks. 
Among these are : 

(a) Maintaining a safe-deposit vault, where space may be 
rented by an individual to keep his valuable papers, jewels, 
etc. The customer does not usually deliver to the bank pos- 
session of the valuables, but himself retains the key to the 

2 Banks in the United States, 1920. 

COMMERCIAL BANKS -Number frOOo'oOO 

National charter : 

National banks 8,030 22,197 

State charter : 

State banks 18,195 14,010 

Loan and trust companies 1,408 8,320 

Private : b 

Private banks 799 213 

SAVINGS BANKS (all state) 

Mutual 620 5,619 

Stock 1,087 1,506 



Total 30,139 51,865 

National 8.030 22:197 

Total state 22,109 29,668 



Ch. 7] THE FUNCTIONS OF BANKS 93 

box, which the bank has no right to open. In larger cities 
this work is often done by separate institutions. 

(b) Acting as money-changer to buy and sell moneys of 
different nations. This function is of less importance in 
America than elsewhere because of the great size of our 
country and of the small portion of our boundaries touching 
those of other nations using different monetary units. More- 
over, the function is in large part performed for Americans 
by ticket agencies at the ports of embarkation and by the 
steamship companies en route. 

(c) Selling bonds and other investments to customers. In 
smaller communities the customers of a bank turn to it as. the 
best source of information for safe investments of personal or 
trust funds. This opens to it a new possibility of service. 
Large investments, however, are usually made through the 
agency of more specialized investment brokers. 

(d) Acting as trustee and business manager for passive 
investors, and especially as executor and administrator of 
estates or as guardian of a minor heir. This function was 
taken up rapidly after about 1890 by trust companies ^ or- 
ganized under state laws, and after 1918 (as a result of an 
act of Congress) by many national banks. 

(e) Receiving time deposits at a low rate of interest to 
lend or invest in securities at a higher rate of interest. Such 
time deposits are not subject to withdrawal by customer's 
check, excepting after notice to the bank (if required). Re- 
ceiving time deposits is the essential function of savings banks 
(as distinct from commercial banks) and will be more fully 
discussed in a later chapter. 

(f) Selling its credit, that is, giving its promise to pay 
at some other place, or at some other time, in return for a 
payment that yields a profit. 

§ 3. The essential banking* function. The one essential 

3 Not to be confused with a trust in the sense of a monopolistic enter- 
prise, with which it has no connection except by mere verbal accident, 
through the word trust. 



94 BANKING AND INSURANCE [Pt. II 

function of a bank is selling (lending) its credit to its cus- 
tomers in some form that will conveniently serve the same 
function as money. A bank of this kind is sometimes de- 
scribed as a business whose income is derived from lending 
its promises. The bank's credit is sold in the form of its 
promises, the evidences of which are its receipts, depositors' 
account books, drafts and checks on other banks, and bank- 
notes. The indispensable condition to the exercise of this 
function by a bank is public confidence in its abilty to fulfil 
its promise to pay whenever it is due. This confidence is 
built upon the bank's paid-up capital; its surplus and un- 
divided profits; the further liability of the stockholders to 
make good any losses up to an amount equal to the capital 
stock each holds ("stockholder's double liability") ; the finan- 
cial prestige of the bank 's officers, directors, and stockholders ; 
the bank's established reputation and "good will" in the 
community after a period of successful operation; the char- 
acter of its loans and of the securities which it owns; and, 
finally, the reliance placed upon the control and inspection 
by official examiners. The bank then may (in addition to 
receiving time deposits) sell its credit in any one or in alil of 
the following foujr ways: (1) by receiving demand deposits; 
(2) by the method of discount and deposit; (3) by selling 
exchange of funds to distant points; (4) by issuing bank- 
notes. 

§ 4. Demand deposits. Demand deposits are those pay- 
able on demand, the demand in practice being by means of 
personal checks requesting the bank to pay to (or on the 
order of) a specified person, or to pay to bearer, A custom- 
er's bank account consisting of demand deposits is called a 
checking account. Since the turn of the century it has be- 
come increasingly the practice to pay a low rate of interest 
(about 2 per cent) on current balances, oftener to large 
depositors. Banks attract demand deposits mainly by the 
convenience and economy which they offer to their customers 
in the guarding of funds from theft and fire and in sa^dng 



Ch. 7] THE FUNCTIONS OF BANKS 95 

the time, trouble, and expense of carrying money for making 
payments. A deposit in a bank is to the depositor for most 
purposes ''just as good" as money in the pocket and for 
many purposes is even better. Thus the banks have become 
the custodians of a large proportion of the money (or funds) 
needed for current use by individuals and business corpora- 
tions. Large amounts of deposits (though only a small pro- 
portion of the total) are brought to the banks in the form 
of bags and rolls of money, or as funds consisting of credit 
papers, such as checks and drafts, calling for the payment 
of money. But most deposits are created in another manner 
now to be described. 

§ 5. Discount and deposit. The process of discount and 
deposit is the purchase of the promissory note of a customer,* 
the price being a credit in the form of a demand deposit 
on the books of the bank. This — the central and most char- 
acteristic banking operation — has something of mystery in 
it at first view. In simple deposit, described in the last 
section, the bank becomes the debtor and the depositor be- 
comes the creditor of the bank. But in discount and deposit 
the depositor brings no money, and the credit paper that he 
gives is his own promise to pay, whereby he becomes the 
bank's debtor. For example, when a bank discounts a $1000 
note for three months and credits its customer with the pro- 
ceeds, its deposits are at that moment increased (let us say) 
$985. Notice that hereby the bank does not add a cent to 
the cash in its vaults while it has added to its liabilities pay- 
able on demand. As an offsetting asset it holds the note of 
its customer receivable at some future time. Most of the 
loans and discounts of -commercial banks serve thus to create 
deposits, and the two items (loans and deposits) rise and 
fall in about the same ratio. In 1920 in all reporting banks 
(exclusive of the twelve Federal Reserve banks) individual 
deposits were $38,000,000,000 and loans were $31,000,000,000. 

4 Usually with deduction of interest in advance; a process called 
discount. See Vol. I. pp. 275, ,302. 



96 BANKING AND INSURANCE [Pt. II 

§ 6. Nature of banking reserves. Banks would have noth- 
ing to gain by receiving deposits or by issuing notes if 
they were obliged to keep in the vaults actual money to the 
amount of their deposits and outstanding notes (unless they 
were paid by depositors for taking care of deposits). It 
was found necessary in practice for banks to keep on hand 
money amounting to only a fraction of all their outstanding 
obligations in order to be able to pay promptly all due de- 
mands under ordinary business conditions. The sum thus 
kept on hand is called the reserve or the reserves of the bank, 
and this is frequently expressed as a percentage of reserves 
against deposits or against note issues, respectively, or of 
both together. Frequently, as in the United States, a mini- 
mum percentage of reserves is fixed by law.^ 

A bank's reserves consist, first, of the lawful money that 
it actually holds in its vaults at any moment, and, secondly, of 
certain other credit items in other banks or with the govern- 
ment, of such a nature that a bank is permitted to count them 
as though immediately available. 

The explanation of the adequacy of a mere fractional re- 
if he would avoid overdrawing his account, must at most 
mand ® and in the effective way in which a checking account 
serve is found in the nature of the individual monetary de- 
serves as a substitute for actual money.'' Every customer, 
times keep a goodly balance to his credit that he does not 
immediately need. Many individuals and corporations must 
at times keep very large balances. The times of maximum 
monetary need of the customers of a bank never exactly 
coincide, and many payments are made among the customers 
of a single bank, requiring only bookkeeping transfers. A 

5 The legal requirements as to minimum reserves vary greatly from 
no specific per cent to 40 or more in different countries, for different 
classes of banks, and for different purposes. Some examples of legal 
reserve requirements in the United States occur in the two following 
chapters. 

6 See ch. 4, § 5. 

7 See below, § 11. 



Ch. 7] THE FUNCTIONS OF BANKS 97 

fractional reserve is therefore ordinarily fully adequate, 
although with any less than 100 per cent reserve any bank 
would be insolvent if all of its demand obligations were pre- 
sented at the same instant. Such an extreme condition is 
made impossible by business custom and public opinion, es- 
pecially among the larger customers of banks ; but the panic 
of small depositors and the urgent need of larger ones often 
bring about a dangerous situation, in which banks with 
abundant assets find their reserves nearly or quite exhausted. 
To prevent the breakdown of the separate banks and of the 
whole banking system at such times, by providing ways of 
replenishing the reserves, is a large part of the ''banking 
problem." 

§ 7. Time deposits. Time deposits are funds to the 
credit of customers which, by agreement, are to be left for 
some specified minimum time or on condition that the bank 
may require notice in advance of the depositor's intention to 
withdraw them. The notice that may be required is usually 
from thirty to ninety days; but only in times of general 
financial crises or of runs on particular banks is this require- 
ment enforced. A sufficient deterrent to irregular withdrawal 
of funds is usually found in the loss of interest if deposits 
are withdrawn at other than stated times. The bank's right 
to require notice makes prudent the investment of a much 
larger proportion of its deposits and for a longer time ; it 
reduces the proportion of deposits needed for reserves, and 
yet reduces the danger of a "run" upon the bank in time 
of financial distress. T! ese are reasons why banks can and 
usually do pay interest on time deposits (at from 2 to 4 per 
cent), as until more recently they rarely did on demand de- 
posits. From the standpoint of the depositor a time deposit 
is, by its very nature, an investment and not a demand credit 
available for current monetary uses. Only that portion of 
a person's capital that for some more or less considerable 
period is not likely to be needed for other purposes ought 
to be put into time deposits. A bank, however, is generally 



98 BANKING AND INSURANCE [Pt. II 

a much safer place in which, to keep a fund of purchasing 
power for the future than is the strongest private treasure- 
box. Receiving time deposits is the one essential function of 
savings banks, but this function is increasingly performed by- 
other banks.® In some eases time deposits are cared for by a 
separate department and kept separate from the general busi- 
ness of a commercial bank. 

§ 8. Bills of exchang^e, domestic. Foreign and domestic 
exchange is the sale of orders for the payment of specified 
sums of money at distant points. But for this, payments at 
distant points would ordinarily have to be made by send- 
ing the money in some way. It must often occur, for ex- 
ample, that hundreds of payments, aggregating millions of 
dollars, must be made by persons in and near Chicago to 
those in and near New York, while, at the same time, equally 
large sums are due from New York to Chicago. The waste- 
ful process of shipping these sums back and forth is avoided 
by the cancellation of indebtedness between the two localities. 
It has been the practice for each small bank to keep a part 
of its funds in correspondent banks in one or more of the 
larger cities on which it draws bills of exchange for its cus- 
tomers and to which in turn it remits for collection drafts 
and checks which it has received. Before 1914 such deposits 
might, up to a certain percentage, be coulnted as part of the 
depositing bank's legal reserves. From time to time, as 
balances of accounts increase on the one side or the other, 
shipments of actual money become necessary; but these are 
only a small fraction of the total amount of the bills of 
exchange mutually cancelled. Similarly, the settlement of ac- 
counts between any two localities can be made by the ship- 
ment of comparatively small sums of money. Under the 
Federal Reserve Act the reserve banks have in various ways 

8 The Federal Reserve Act of 1913 has given encouragement to this 
practice by reducing to 3 per cent the reserve required to he kept 
against time deposits. See ch. 9, § 7. 



Ch. 7] THE FUNCTIONS OF BANKS 99 

assumed the functions of the correspondent banks, aiming 
to bring about parity of cheeks issued in any part of the 
country. 

The wider use and acceptance of individual checks at long 
distances from the banks upon which they are drawn limit 
by so mu,ch the proportion of special bills of exchange drawn 
by the banks themselves. Domestic exchange involves just 
the same principles as foreign exchange of funds, except that 
in the latter, usually, two different units of standard money 
are used. In connection with the discussion of foreign trade 
below, foreign exchanges will be explained and further light 
will be thrown upon the adjustment of the money supplies 
and levels of prices of the various sections of a single country, 
as well as between different countries. 

§ 9. Issues of notes. The issue of bank-notes as a mode 
of lending a bank's credit calls for consideration here. Yet 
it must be observed at once that comparatively few banks in 
the world have now the legal right to issue their own notes. 
The function of bank-note issue has come to be looked upon as 
so closely connected with that of the coinage and regulation 
of the standard money that it has been increasingly limited 
in each country to a central national bank, or group of banks, 
which is in many respects practically an organ of the govern- 
ment. To such banks the right of note issue is granted as 
a monopoly in return for specified payments and services. 
In normal times the issues of bank-notes are regulated by 
the banks themselves ; but in times such as those following the 
outbreak of the World "War the bank-note issues become es- 
sentially political money (irredeemable) issued by command, 
and to meet the urgent financial needs, of the sovereign state. 

No two countries have quite the same kind and system 
of bank-notes. Typical bank money ( or ''credit currency") 
consists of notes issu,ed by banks on the credit of their gen- 
eral assets, without special regulation by law. Many of the 
bank-notes issued by the banks chartered by either the federal 
or the state governments before the Civil War were of this 



100 BANKING AND INSURANCE [Pt. II 

kind; but after 1837 the notes of the Second Bank of the 
United States, which had been prudently controlled, were 
retired. The experience with many (not all) of the state 
bank-notes issues thereafter, until the Civil War, was less 
fortunate. As it was to the interest of the banks to keep 
in circulation as many notes as possible, many banks yielded 
to the temptation to abuse the power of note issue. The 
period is known as that of "wild-cat" banking. In 1866 a 
federal tax of 10 per cent on state bank-notes made their 
issue unprofitable. 

Since the passage of the Federal Reserve Act we have 
temporarily two kinds of bank-notes, the old bond-secured 
notes, in use since 1863 (very different from the typical 
form),^ and the new kind of Federal Reserve notes very 
nearly typical in character but issued only by the Federal 
Reserve banks, not by individual banks. 

A bank, by the issue of notes, puts into circulation as money 
its own promises to pay. The customer, in borrowing money 
or in withdrawing deposits or cashing cheeks and drafts from 
other banks, is paid with the bank's notes instead of with 
standard money. These notes may be returned to the issuing 
bank, either to be redeemed in specie or to be paid in some 
other form of credit, such as deposits or exchange. The limit 
of the issue of such notes is the need of the community for 
that form of money, and if they are promptly redeemed in 
standard money on demand, they never can exceed that 
amount. A holder of a note (in the absence of special regula- 
tions) has the same claim on the bank that a depositor has. 

§ 10. Divergent views of typical bank-notes. Some per- 
sons, seeing in bank-notes but a form of ordinary commercial 
credit (like the promissory note or an individual's check), 
have contended that their issue should be entirely unlimited 

» Including, now, two varieties: the "national bank-notes," issued, 
as before, through local banks, and some "Federal Reserve bank-notes," 
which are national bank-notes that have been taken over by the Federal 
Reserve banks. 



Ch. 7] THE FUNCTIONS OF BANKS 101 

and unregulated except by the ordinary law of contract which 
makes the bank liable to redeem the notes on demand. Such 
bank-notes would not be legal tender, and every one would 
be free to take or refuse them as he pleased. Each bank 
would thus put into circulation as many notes as it couild; 
and, as they would constantly be returned for redemption 
when not needed as money, their volume would expand and 
contract with the needs of business. 

It may be conceded that there is much truth in this view, 
but not the whole truth. For, in reality, when bank-notes 
are in common use, every one is compelled to take the money 
that is current. This offers a constant temptation to the 
reckless and unscrupulous promotion of banking enterprises, 
as has been repeatedly shown, notably in America in the days 
of ' ' wild-cat ' ' banking. The average citizen cannot know the 
credit of distant banks, and thus has not the same power 
of judging wisely in taking bank-notes that he has even in 
making deposits in the bank of his own neighborhood. Be- 
tween bank-notes and ordinary promissory notes there are 
other differences. Bank-notes pass without endorsement, and 
thus depend on the credit of the bank alone, not, like cheeks, 
on the credit of the person from whom received. Unlike 
ordinary promissory notes, they yield no interest to the 
holder. They go into circulation and remain in circulation 
for considerable time by virtue of their monetary character 
in the hands of the holders. Thus they approach political 
money in their nature, and the banks are near to exercising' 
the sovereign right of the issue of money. 

At the other extreme of view have been those who consider 
bank-notes to be essentially of the nature of political money. 
If they are so, it is argued, the power of issue should not be 
exercised by any but the sovereign state. In this view it is 
overlooked that bank-notes, unlike inconvertable paper money, 
depend for their value on the credit of the bank, not on their 
legal-tender quality and on political power.^" They must 

10 In some cases, as during the bank restriction in England, 1797- 



102 BANKING AND INSURANCE [Pt. II 

be redeemed on penalty of insolvency ; government notes need 
not be, and yet will circulate at par if properly limited. Ade- 
quate provisions for the prompt return and redemption of 
bank-notes makes them "elastic" in their adaption to mone- 
tary needs, which fluctuate with changes in commerce and 
industry from season to season and even from day to day. 

The predominent opinion to-day is that in their economic 
nature bank-notes share to some extent the character both 
of private promissory notes and of political paper money. In 
ordinary times they stand midway between the two, though 
in war financing they may virtually become merely fiat notes. 
Everywhere it has come to be held that the issue of paper 
money of any kind is in its nature a public monopoly, and 
yet everywhere the bank-note policy has come to be that of 
permitting the issue only to certain institutions, under strict 
public legislation and regulation, and of requiring in return 
for this privilege some substantial services of payments to 
the government. 

§ 11. Banking' credit as a medium of trade. The credit 
which, in various ways, banks sell ^^ serves, in most cases, 
the purposes of money to their customers. On the contrary, 
this is not usually true of time deposits, for the motive of 
the depositor in such cases is usually to invest his funds for 
a time rather than to keep them available as money. How- 
ever, there are many cases in which persons save for some 
moderately distant use — such as the purchase of furniture, 
of a piano, of a house. The safety and convenience of time 
deposits, combined with the reward of a small rate of interest, 
cause great sums, in the aggregate, to be deposited as tempo- 
rary savings, which otherwise would be hoarded in the form 
of money and thus withdrawn from circulation. In such 
cases the time deposit may serve both as an investment and 
as a monetary fund for future use. This is a great economy 

1821, and after 1914 in all the European countries, bank-notes become 
inconvertable — practically political money. 
11 See above, § 3. 



Ch. 7] THE FUNCTIONS OF BANKS 103 

in the use of money, for experience shows that in the savings 
banks of America the average reserves of actual money kept 
against deposits are only about IV2 per cent. In countries 
where banks are little known, the amount of actual money 
hoarded is therefore vastly greater than it is in the United 
States, where there are $6,500,000,000 of individual deposits 
in regular savings banks, besides large sums in time deposits 
in commercial banks. 

Demand deposits, while not money, clearly perform the 
function of a reserve of purchasing power for depositors, and 
reduce by so much the amount of money each must keep 
at hand to meet his current needs of purchasing power. 
If the depositor's credit balance bears no interest, he has no 
motive to keep a balance greater than he would require of 
actual money, and he has the motive to spend it or invest 
it in income-bearing capital whenever his balance (plus his 
cash in hand) exceeds his monetary needs. Payment of in- 
terest on credit balances reduces the motive to withdraw for 
investment elsewhere any such excess, and mingles in the 
depositor's thought monetary and investment motives. De- 
mand deposits are often spoken of (somewhat inaccurately) as 
"deposit currency," being funds at the command of de- 
positors which are as disposable and as active and current for 
the monetary function as so much acti^al money would be. It 
is estimated that the rate of turnover of deposits in the 
United States is about fifty times a year. We may view the 
demand deposits subject to cheek as either a substitute for 
money or as a means by which the rapidity of circulation and 
the monetary efficiency of actual money held in bank re- 
serves is multiplied manyfold.^^ 

12 In the United States in 1920 individual deposits in banks could 
be classified as follows: 

Payable on demand $17,500,000,000 

Time deposits (or not classified) 20,200,000,000 

Total 37,700,000,000 

Of the total $14,000,000,000 were in national and $23,700,000,000 were 



104 BANKING AND INSURANCE [Pt. II 

The method of payment by bank drafts in domestic ex- 
change reduces the need for, or increases the efficiency of, 
money in just the same way as does the use of checks. By 
the mutual credit of banks in different parts of the country, 
very large payments may be made in both directions with 
the movement of only the comparatively small amount of 
physical money needed to pay the balance after the cancella- 
tion of drafts, bills of exchange, and checks. 

The use of bank-notes reduces the amou|nt needed of other 
kinds of money more directly, though not more effectively, 
than do deposit accounts. Bank-notes are money, and as 
long as their amount is limited by prompt redemption they 
circulate instead of so much of other kinds of money. Re- 
demption is possible by the use of a reserve of standard (or 
of legal-tender) money very much smaller than the amount 
of notes outstanding. 

§ 12. Productive services of banks. There have always 
been some erroneous ideas regarding the magic power of 
banks to multiply the power of money. But there should 
be no more mystery about banking credit than about the 
nature of money itself. Banks are the labor-saving machin- 
ery of finance. They gather loanable funds, reduce hoard- 
ing, make money move more rapidly, and create a central 

in other banks. All the demand deposits were subject to check, ex- 
cepting $1,300,000,000 of demand certificates. Of the time deposits 
$7,500,000,000 were in savings accounts, $2,600,000,000 in time certi- 
ficates, and $10,100,000,000 not classified, of which a large part was 
"time deposits on open account," for the withdrawal of which ordi- 
narily no notice is required. It appears, therefore, that at least 
$25,000,000,000 of deposits are almost as good as cash in hand for the 
depositors' current needs. This was more than four times the 
$6,000,000,000 of cash in circulation and in banks at the same time, 
and was twenty-five times the $1,000,000,000 cash in these same banks 
(the Federal Reserve banks not included) at that time. These figures 
indicate the great influence that banking has in increasing the average 
efficiency of the circulating medium of the country. (Figures from 
Annual Report of the Secretary of the Treasury, 1920, pp. 1188, 1430, 
1431). 



Ch. 7] THE FUNCTIONS OF BANKS 105 

market between borrowers and lenders for the sale of credit. 
While not creating more physical wealth directly, they add 
to the efficiency of wealth; they simplify and quicken the 
movement of nearly all commercial transactions. Banks per- 
form incidentally a further service in developing better busi- 
ness methods in the community. They enforce promptness 
and exactitude in business dealings. In supplying credit to 
enterprises banks are constantly passing judgment on the 
collateral security presented to them and on the soundness 
of the enterprises that are seeking support. This gives to 
bankers great economic power, capable at times of misuse 
in political and social affairs, especially where a group of 
men comes to exercise a practical monopoly of business credit 
in any community, and uses this power for its own greedy 
and selfish ends. 

§ 13. Earnings of banks. The earnings of banks are 
drawn from different sources, according to the size of the 
community and the nature of the banks. While in the 
villages and smaller cities the commercial banks perform a 
number of functions, in the larger cities they usually specialize 
in a far greater degree. The trust companies, however, 
with their greater versatility have been increasing in number. 
The earnings of banks are derived from discounts, interest on 
their own capital, charges for exchange and collection, 
dividends, interest and rents on investments, and profit from 
their bank-notes. The capital with which a bank starts in 
business ^^ could be lent with less trouble and more cheaply 
without starting a bank, but used as a banking capital it can 
be lent in part while still serving to attract deposits, which 
are the main source of the income of banks to-day. In the 
past it has been customary for many banks, especially "coun- 
try banks," to charge for remittances and for the collection 
of checks from other banks; but under the Federal Reserve 
system great progress has been made toward parity of ex- 
change, or parity of checks, everywhere in the United States. 

13 See above, § 3. 



106 BANKING AND INSURANCE [Pt. II 

While many small banks have strenuously opposed this be- 
cause it cuts off a considerable source of revenute, they gain 
in other ways by performing this service freely for their cus- 
tomers. Banks make few investments in real estate or other 
physical property; it is, in fact, their duty to keep out of 
ordinary enterprises; but they are forced sometimes to take 
for unpaid debts things that have been held as security. 
Profits on bank-notes have at times been the main, almost the 
sole, motive for starting banks ; but that is not the case to-day, 
when the right of issue is so strictly limited. 

Refeeences. 

Agger, E. E., Organized banking. P. 385. New York. Holt. 1918. 
Cleveland, F. A., Funds and their uses. N. Y. Appleton. 1902. 
Conant, C. A., History of modern banks of issue. 5th ed. N. Y. 

Putnam. 1915. 
Dunbar, C. F., Theory and history of banking. New ed. N. Y. 

Putnam. 1917. 
Fishe, A. K., The modern bank. N. Y. Appleton. 1903. 
Holdsworth, J. T., Money and banking. N. Y. Appleton. 1914. 
Phillips, G. A., ed., Readings in money and banking. N. Y. Mae- 

millan, 1916. Chs. IX, X. 
Same, A study of the principles and factors underlying advances 

made by banks to borrowers. P. 374. New York. Macmillan. 

1920. 
Pratt, S. S., The work of Wall Street. P. 447. An account of the 

functions, methods, and history of the New York money and 

stock markets. New York. Appleton. 1921. 
Scott, W. A., Money and banking. N. Y. Holt. 1916. 
White, Horace, Money and banking illustrated by American History 

Bost. Ginn. 1914. Bk. III. Chs. I-III. 



CHAPTER 8 



BANKING IN THE UNITED STATES BEFORE 1914 

§ 1. The First and Second Banks of the United States. § 2. Bank- 
ing from 1836 to 1863. § 3. National Banking Associations, 1863- 
1913. § 4. Defects of our banking organization before 1913. § 5. 
Lack of system. § 6. Inelasticity of credit. § 7. Periodical local con- 
gestion of funds. § 8. Unequal territorial distribution of banking 
facilities. § 9. Lack of provision for foreign financial operations. 
§ 10. The "Aldrich plan." 

§ 1. The First and Second Banks of the United States. 
The form of our present banking system has been affected by 
various economic and political events, a knowledge of which 
is helpful to an understanding of the present banking system 
in our country. 

Alexander Hamilton, the great first Secretary of the Treas- 
ury in Washington's eabinet, advocated the charter of a cen- 
tral national bank as one portion of his larger plan of na- 
tional financiering. His purpose was realized in the charter- 
ing, in 1791, of the First Bank of the United States for a 
period of twenty years. The capital for this institultion was 
in small part subscribed by the government, but mostly by 
private capitalists. The management of the bank was left 
almost entirely in private hands. The central bank estab- 
lished branches in many parts of the country, issued bank- 
notes which circulated everywhere without depreciation, acted 
as the governmental depository of funds and as governmental 
agency in various ways. It seems to have been successful 
and useful as a banking institution until the expiration of its 
charter in 1811, but it was touched by the contemporary con- 
troversies over state rights and was from the first opposed by 

107 



108 BANKING AND INSURANCE [Pt. II 

those who feared the growth of a strong central government. 
This opposition prevented the extension of its charter. 

In 1816, however, after only a moderate discussion, the 
Second Bank of the United States was chartered for a period 
of twenty years. This, also, in its purely banking aspects, 
seems to have been distinctly successful, conducting numerous 
branches in various parts of the country, maintaining at all 
times the parity of its notes, facilitating domestic exchange 
throughout the country, and enjoying unquestioned credit and 
solvency. However, this bank became, even in a greater de- 
gree than did the First Bank, the creature of political rival- 
ries. In the period of rising democratic sentiment typified 
and led by Andrew Jackson, the bank came to be looked 
upon as the embodim-ent, or the stronghold, of plutocratic 
interests. Jackson's suspicions and hostility to a central 
bank were magnified by the untactful conduct of the head 
of the bank, and Congress permitted its charter to expire 
by limitation in 1836, near the close of Jackson's administra- 
tion. In the light of history the change of policy must be 
pronounced iinfortunate, the more so because it committed 
the then leading political party to opposition against a bet- 
ter organization of banking on a national scale. The action 
was directly that of Jackson, but the fixing of the blame 
is not an entirely simple thing. 

§2. Banking from 1836 to 1863. The federal govern- 
ment, which up to that time had deposited its funds in the 
central bank and its branches, and in local state banks, es- 
tablished the "independent treasury" in 1840. This was 
abolished in 1841, but reestablished in 1846, and continuously 
maintained until January, 1921, when the Federal Reserve 
Board took over all nine of the offices and sub-treasury 
branches. By this plan the government kept its money of 
all kinds in various depositories (or sub-treasuries) in charge 
of public officials. While from 1792 to 1836 almost eon- 
tinuou'sly a central banking system was in operation, other 
banks, organized under state charters, were steadily increas- 



Cir. 8] BANKING IN THE UNITED STATES BEFORE 1914 lO'J 

iiig in number. They received deposits, issued bank-notes 
under state laws, and eared for local commercial needs. The 
abolition of the central national bank in 1836 left to the 
various state-chartered banks for twenty-seven years all the 
banking functions of the country. A few of the states be- 
came stockholders in central state banks, or even undertook 
to conduct a banking business, with unsatisfactory results. 
The banks of some states (notably those of New England and 
New York), conducted as private enterprises under care- 
ful regulation and held to strict standards by public senti- 
ment, for the most part maintained a high credit ; but many 
banks, under lax laws and regulations, were guilty of great 
abuses of credit and of downright dishonest practices. The 
evils were more especially apparent in connection with exces- 
sive issues of bank-notes. 

§ 3. National Banking- Associations, 1863-1913. No 
further step was taken in federal legislation until 1863, when, 
in the midst of the Civil War, local "national banking asso- 
ciations" were chartered. The purpose was in part to pro- 
vide banks under national charters for banking purposes 
(both of deposit and of issue), and in part it was to make a 
wider market for United States bonds at a time when govern- 
ment credit was at low ebb. The plan adopted followed the 
experience of New York state (from 1829 on) with a system 
of bond-secured banknotes. Congress provided that every 
bank taking out a national charter must purchase bonds of 
the United States and deposit them with the Treasurer of the 
United States, in return for which it would receive bank- 
notes to the amount of 90 per cent of the denomination or 
of the market value of the bonds, whichever was the smaller. 
(In 1900 this was changed so that notes could be issued 
to the full amount of the denomination of the bonds.) Notes 
of failed banks or of banks that go out of business are re- 
deemed from the guaranty fund held at Washington and from 
the proceeds of the sale of the bonds. Bank-notes issued 
on this plan, being secured by the bonds and a redemption 



110 BANKING AND INSURANCE [Pt. II 

fund, rest ultimately on the credit of the government, not 
on the credit of the bank. They are not promptly sent 
back for redemption to the banks issuing them, as should be 
done if they were typical bank-notes. They may circulate 
thousands of miles away from the bank that issued them, and 
for years after the bank has gone out of business. They are 
perfectly safe for the holder, bu,t are not an ''elastic cur- 
rency," increasing or diminishing with the needs of business. 
The changes in their amount depend upon the chance of the 
banks to make more or less in this way than by any other 
use of their capital, and this in turn depends largely on the 
price of bonds and on the rate of interest they bear. From 
1864 to 1870 fortunes were made from this sourcei, but there- 
after banks could make little more from note issues than they 
could by investing the same amount in other ways. Many 
banks for a long period did not avail themselves in the least 
of their privilege of issue. The notes were subject to a 
tax.^ 

A national bank (as the law now stands) may be organized, 
with $25,000 capital in towns not exceeding three thousand 
population, with $50,000 in towns not exceeding six thou- 
sand, with $100,000 in cities not exceeding fifty thousand, 
and with $200,000 in large cities. Three cities, New York, 
Chicago, and St. Louis, have long been designated as central 
reserve cities, and some forty-seven other cities as reserve 
cities, in which the reserves of banks have always been re- 
quired to bear a considerably larger proportion to their de- 
posits than in other cities.^ Other banks might, until 1914, 
count as part of their legal reserves their deposits in reserve 

1 In recent years that has been one half of 1 per cent when 2 per 
cent bonds and 1 per cent when bonds bearing a higher interest were 
deposited. 

2 In reserve, cities 25 per cent and in other cities 15 per cent. The 
details of the regulations in the old law (given in part below, § 7) 
were all altered by the legislation of 1913, effective late in 1914. 



Ch. 8] BANKING IN THE UNITED STATES BEFORE 19M 111 

city banks, up to a certain proportion. The national banks 
in the larger cities thus became the great capital reservoirs 
of cash for the whole country. 

National banks have been subject to stricter inspection than 
have been the banks in most of the states, a fact that has 
strengthened public confidence in their stability. Except in 
this and the other respects above mentioned, a national char- 
ter offered few, if any, attractions to small banks, a majority 
of which have found it more advantageous to operate under 
state charters because of less stringent regulations as to 
amount of capital, reserves, and supervision. 

§ 4. Defects of our banking- organization before 1913. 
Taken altogether, the national banks in the United States 
between 1863 and 1913 represented great banking power and 
very efficient service for the community in times of normal 
business, as with few exceptions did also the state banks. 
But in several respects it long ago became apparent that 
our banks were operating iless satisfactorily than those of 
several other countries. American banking organization had 
failed to keep pace with the increasing magnitude and diffi- 
culty of its task. Especially at the recurring periods of 
financial stress, such as those of 1873, 1893, 1903, and 1907, 
our banking machinery showed itself to be wofully unequal 
to the strain put upon it. Financial panics were more acute 
here than in any other land, and this fact clearly was trace- 
able in large part to defects in the banking situation. In 
academic teaching and in public conferences of bankers, busi- 
ness men, publicists, and students, the subject was continually 
discussed after 1890. At length Congress in 1908 created a 
"National Monetary Commission" to inquire into and report 
what changes were necessary and desirable in the monetary 
system of the United States or in the laws relative to bank- 
ing and currency. After the most extended inquiry and dis- 
cussion that the subject had ever received, the commission 
submitted its report in January, 1912. The defects to be 



112 BANKING AND INSURANCE [Pt. II 

remedied, as enumerated in the report^ may be reduced to 
the following five headings: (a) Lack of system, (b) In- 
elasticity of credit, (c) Periodic local congestion of funds. 

(d) Unequal territorial distribution of banking facilities. 

(e) Lack of provision for foreign banking. 

§5. Lack of system. Only in a loose sense could the 
banks of the United States be said (before 1914) to constitute 
a system at all. Both national and state laws dealt with indi- 
vidual banks only. It was not legal for a bank to establish 
branches in another city, as is done in most countries. The 
several national banks in one city were legally quite separate. 
It was only by voluntary agreement that in some of the larger 
cities they came together into clearing-house associations. 
They made possible some measure of cooperation which, small 
as it was, proved at times of stress to be of much service 
within a limited sphere for the local communities. But even 
with the aid of these organizations the banks were unable in 
times of emergency to avoid the suspension of cash payments. 

There was no provision whatever for the concentration of 
bank revenues so that each bank would be supported by the 
strength of the other banks if a movement began to withdraw 
deposits in unusual amounts. Each bank then was compelled 
for self -protection to call for any sums it had deposited with 
other banks,* and to keep for its own use all the reserves it 
might have in excess of its own immediate needs. This 
threw a great strain upon the banks in the reserve cities, 
which in normal times had become the depositories of a good 
part of the reserves of the banks in other places. Thus de- 
veloped a spirit of panic, like the fright of theater-goers 
crowding toward the door at the cry of fire. 

The maintenance of the government's independent treasury 
contributed to the difficulties by causing the irregular with- 
drawal of money from circulation and thus depleting bank 

3 The expressions within quotation marks in the following sections 
are taken from this report. 

4 See further on this in § 7 on periodical congestion of funds. 



Ch. 8] BANKING IN THE UNITED STATES BEFORE 1914 113 

reserves in periods of excessive goverument revenues and by 
returning these funds into circulation only in periods of 
deficient revenues. Efforts to modify this system by a partial 
distribution of the public moneys among national banks, had 
resulted, it was charged, in discrimination and favoritism in 
the treatment of different banks and of different sections of 
the country. 

§ 6. Inelasticity of credit. Our banks, considered both 
separately and collectively, were unable to increase their lend- 
ing powers quickly and easLly to respond to business needs. 
The need cf greater elasticity of credit was felt in the more or 
less regular seasonal variations within the year, and in the 
more irregular variations in cycles of years from periods of 
prosperity to those of panic and depression in business. The 
inelasticity was necessitated by illogical federal and state laws 
restricting absolutely the further extension of credit when the 
reserves fell below the percentage of deposits (15 or 25 per 
cent) fixed by law. Keserves thus could not legally be used 
to meet demands for cash pajanents at the very time when 
most needed. This feature has been likened to the rule of the 
prudent liveryman who always refused to allow the last horse 
to leave his stable so that he would never be without a horse 
when a customer called for one. The refusal of credit by 
the banks at such times when they still had large amounts of 
cash in their vaults increased the need and eagerness of the 
public to draw from the bank all the cash they could, and 
often precipitated the insolvency of the banks. Clearly, some 
means were needed to enable the lending power of the indi- 
vidual banks to be increased at such times, so that no customer 
with good commercial paper need fear to be refused a loan 
even though the rate of interest might have to be somewhat 
higher for a few days or weeks than the normal rate. 

Our bond-secured bank-notes lacked almost entirely the 
quaility of elasticity needed to meet these changing business 
needs."* Their value being dependent primarily upon the 

<• See above, § 3. 



114 BANKING AND INSURANCE [Pt. II 

amount and price of United States bonds, they might be most 
numerous just when least needed as a part of our circulating 
medium. 

§ 7. Periodical local congestion of funds. In times of 
general confidence each bank finds it profitable, and is 
tempted, to extend its credit to the extreme limit permitted 
by the law governing the proportion of reserves to deposits. 
Of the 15 per cent reserves that were required in the so-called 
"country" banks, three fifths (9 per cent) might be kept in 
banks in reserve cities; and of the 25 per cent in reserve 
city banks, 121/0 per cent might be kept in central reserve 
cities. There it counted as part of the depositing banks' 
legal reserves, was a fund upon which domestic exchanges 
could be drawn, and earned a small rate of interest (usually 
2 per cent) paid by banks in reserve and central reserve 
cities to their "country" correspondents. By this process 
of pyramiding, reserves in very large part came to be kept 
in New York city, where they could be lent "on call," and 
the largest use for call loans was in stock-exchange specula- 
tion. Thus every period of prosperity encouraged an un- 
healthy distribution of reserves, gave an unhealthy stim- 
ulus to rising prices, and "promoted dangerous specula- 
tion." 

§ 8. Unequal territorial distribution of banking facilities. 
Another aspect of this concentration of surplus money and 
available funds in the larger cities was the comparatively 
ample provision of banking facilities in the cities and in the 
manufacturng sections, and imperfect provision in the agri- 
cultural districts. The whole financial system seemed de- 
signed to induce the poorer country districts to lend tempo- 
rarily available funds at low rates of interest to be used 
speculatively in cities, instead of enabling the richer districts, 
the cities, to lend to the rural districts for productive enter- 
prise. The rates of bank discount in different sections of our 
country have long been most unequal — lowest in the largest 
cities and highest in the rural South and West — whereas in 



Ch. 8] BANKING IN THE UNITED STATES BEFORE 1914 115 

Canada, with a different system of banking, the rates have 
long- been much more approximately uniform in urban and 
agricultural districts. 

Indeed, our national banking development has been pre- 
dominately urban and commercial to the neglect of rural and 
agricultural interests. National banks were (until 1913) for- 
bidden to make loans on real estate, and this greatly "re- 
stricted their power to serve farmers and other borrowers 
in rural communities." There was in the more agricultural 
regions, "no effective agency to meet the ordinary or unusual 
demands for credit or currency necessary for moving crops or 
for other legitimate purposes." The lack of uniform stand- 
ards of regulation, examination, and publication of reports 
in the different sections prevented the free extension of credit 
where most needed. Finally, the methods and agencies for 
making domestic exchange of funds were, compared with 
other countries, imperfect and uneconomical even in normal 
times, and could not "prevent disastrous disruption of all 
such exchanges in times of serious trouble." 

§ 9. Lack of provision for foreign financial operations. 
Not without its influence on public opinion was the considera- 
tion that we had "no American banking institutions in for- 
eign countries. ' ' Many bankers and business men felt, as did 
the Commission, that the time had come when the organiza- 
tion of such banks was "necessary for the development of our 
foreign trade." Foreign banks in South America and the 
Orient, handling American trade, were believed to favor their 
own countrymen rather than the interests of American mer- 
chants. In contrast with the European nations with their 
centralized control of banking, we had "no instrumentality 
that ' ' could ' ' deal effectively with the broad questions which, 
from an international standpoint, affect the credit and status 
of the United States as one of the great financial powers of 
the world. In times of threatened trouble or of actual panic 
these questions, which involve the course of foreign exchange 
and the international movements of gold, are even more im- 



116 BANKING AND INSURANCE [Pt. II 

portant to us from a national than from an international 
standpoint. ' ' 

§10. The "Aldrich plan." The report of the National 
Monetary Commission represented most careful study of the 
whole subject, and embodied the efforts and aid of many of 
the best financial experts of this and other lands. The Com- 
mission in its work gave an admirable example of the right 
way to prepare for and undertake important economic legis- 
lation. Though it discovered nothing essential that was not 
known to the small group of expert economic students, it 
put all material into systematic and convincing form and 
served during several years to educate public opinion as to the 
needs and proper means of sound banking policy. The analy- 
sis of difficulties as outlined above has not merely a tempo- 
rary but a lasting interest to the student of financial history, 
for it implies an ideal for the banking system of the nation. 

The Commission submitted with its report a constructive 
plan which was known by the name of the Commission's 
chairman. Senator Aldrich. This plan was embodied in a 
bill for a National Reserve Association, a bank for banks, 
which bore some likeness to the great central banks of Europe. 
In the many details of the plan an effort was made to remedy 
every one of the difficulties above described and to supply 
all the needs indicated. The plan was favored pretty gen- 
erally by bankers, but called forth many adverse opinions. 
In the year of a presidential election, however. Congress took 
no action in the matter. All parties were pledged to some 
kind of banking reform, but particular proposals were not 
discussed in the campaign. 

Refeeences. 

National Monetary Commission, Report. 1912. In Sen. Doc. 243, 

62d Cong., 2d Cess. 
Phillips. G. A., ed., Readings in money and banking. N. Y. Mac- 

millan. 1916. Ch. XXX. 
United States Comptroller of the Currency, Annual reports. 
White, Horace, Money and banking illustrated by American History. 

Bost. Ginn. 1914. Bk. Ill, chs. IV, XV, XVII, XX, XXI, and 

appendices A and B. 



CHAPTER 9 



THE FEDERAL RESERVE ACT 

§ 1. General banking organization. § 2. The Federal Reserve Board. 
§ 3. Federal Reserve banks. § 4. Federal Reserve notes. § 5. Reserves 
against Federal Reserve notes. § G. Reserves against Federal Reserve 
bank deposits. § 7. Reserves in member banks. § 8. Rediscount by 
Federal Reserve banks. § 9. Clianges in national banks. § 10. Opera- 
tion in the pre-war period. § 11. Operation in the war period. § 12. 
Gold hoards and artificial interest rates. § 13. The post-war period. 
§ 14. Future of the Federal Reserve system. 

§ 1. General banking organization. President Wilson 
and the newly elected Congress with its Democratic majority 
made banking reform one of the main objects on the program 
for the special session beginning March 5, 1913. The result 
was the Glass-Owen bill, which became law as the Federal 
Reserve Act December 23 of that year. The bill was actively 
discussed within and without the halls of Congress, and many 
of its features were attacked by bankers, individually and 
acting through the bankers' associations, at various stages of 
its progress. As a result it underwent numerous amend- 
ments in details, and, though it remained in most essentials 
as it was first proposed, it was at last accepted even by its 
critics as on the whole a beneficent act of legislation. Indeed, 
its strongest critics were the friends of the Aldrich plan, 
and the Federal Reserve Act embodies, in a greater degree 
than its authors were ready to admit, the main features of 
the Aldrich plan. In one important respect, however, it is 
different : it provides for more decentralization of control and 
of reserves than did the Aldrich plan. It created, not one 
central banking reserve, but, in the end, twelve regional, or 

117 



lis 



BANKING AND INSURANCE 



[Pt. I! 





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Ch. 9] THE FEDEEAL RESERVE ACT 119 

district, banks, each to keep the reserves of its district. The 
Jacksonian tradition of opposition to a central hank ^ in 
part helps to explain this ; in part the contemporary congres- 
sional investigation and discussion of the so-called "money- 
trust" and the consequent desire to decrease the importance 
of "Wall Street" and of New York City banking power. 

On the accompanying map (Fig. 1) are given the outlines 
of the districts as constituted and altered down to 1921.^ 

§ 2. The Federal Reserve Board. At the head of the 
banking system stands the Federal Reserve Board of seven 
members, five of them appointed by the President and Senate 
of the United States for this purpose, and two serving ex- 
officio — the Secretary of the Treasury and the Comptroller of 
the Currenc}'. One of the five shall be designated by the 
President as Governor and one as Vice-Governor of the 
Board. But the secretary of the Treasury is ex-officio chair- 
man. The term of the appointive members was fixed at ten 
years and the salary at $12,000 a year. 

The powers of the Board are numerous and important. The 
Board is made the head of a real system of banking, the twelve 
parts of which can, in times of emergency, and at the Board's 
discretion, be compelled to combine their reserves by means 
of lending to each other (rediscounting), to the very limit 
of their resources, at rates fixed by the Board. By this 
means the reserves of the several district banks may be 
"piped together" and thus be practically made into one cen- 
tral bank under the Board's control, although centralization 
was in outward form avoided by the bill. Alongside of the 
Reserve Board is placed a Federal Advisory Council, con- 

1 See ch. 8, § 1. 

2 The law provided that an organization committee should designate 
not less than eight nor more than twelve cities as Federal Reserve 
cities, and should divide the continental United States, excluding 
Alaska, into districts each containing one such city. Twelve districts 
were designed. Whenever, therefore, the act speaks of "not less than 
eight nor more than twelve," or of "as many as there are Federal 
Reserve districts," we may now say twelve. See map, Figure 1, ch. 9. 



120 BANKING AND INSURANCE [Pt. II 

sisting of one member from the board of directors of each of 
the twelve district banks. This council has only the power 
to confer with, make representations and recommendations 
to, and call for information, from the Federal Reserve 
Board. 

§ 3. Federal Reserve banks. The twelve Federal Reserve 
banks, which opened for business November 16, 1914, are 
institutions of a type new in our financial history. They 
are "banks for banks," that is, for the "member banks" in 
their respective districts. Every national bank must, and any 
state bank or trust company may (on agreeing to comply with 
reserve and capital requirements for national banks and to 
submit to federal examination), subscribe for stock to the 
amount of 6 per cent of its capital and surplus, and thus be- 
come a "member bank." The capital of each Federal Re- 
serve bank was to be at least $4,000,000 ; in fact, only two of 
those organized (Atlanta and Minneapolis) had at their open- 
ing less than $5,000,000 capital; the largest (New York) had 
$21,000,000; and the average was $9,000,000. The member 
banks receive dividends of 6 per cent, cumulative, on their 
paid-in shares of capital, and (beginning 1921, by amend- 
ment) all remaining net earnings are added to surplus until 
it amounts to 100 per cent of the subscribed capital; after 
that 10 per cent shall be added to surplus and the rest goes 
to the government as a franchise tax. By the end of 1920 
the total surplus of the system exceeded the subscribed cap- 
ital, and only two of the banks (Cleveland and Dallas) had 
less than 100 per cent surplus. 

Each reserve bank has nine directors, consisting of three 
classes of three men each. Classes A and B are elected by the 
member banks by a system of group and preferential voting 
designed to prevent the large banks from outvoting the smaller 
OQies. Directors of class A are chosen by the banks to repre- 
sent them, and are expected to be bankers ; those of class B, 
though chosen by the banks and though they may be stock- 
holders, shall not l>e officers of any bank, and shall at the 



Cir. 9] THE FEDERAL RESERVE ACT 121 

time of their election be actively engaged within the district 
in commerce, agriculture, or some other industrial pursuit. 
Directors in class C are appointed by the Federal Reserve 
Board, one of them being designated as chairman of the 
board of directors and as Federal Reserve agent. They rep- 
resent the public particularly, and may not be stockholders 
of any bank. 

Any Federal Reserve bank may: 

a. Receive deposits from member banks and from the United 
States. 

b. Discount upon the endorsement of any of its member 
banks negotiable papers, with maturity not more than ninety 
days, that have arisen out of actual business transactions, 
but not drawn for the purpose of trading in stock and other 
investment securities. 

c. Purchase in the open market anywhere various kinds 
of negotiable paper. 

d. Deal anywhere in gold coin and bullion. 

e. Buy and sell anywhere bills, notes, revenue bonds, and 
warrants of the states and subdivisions in the continental 
United States. 

f. Fix the rate of discount it shall charge on each class 
of paper (subject to review by the Federal Reserve Board). 

g. Establish accounts with other Federal Reserve banks 
and with banks in foreign countries or establish foreign 
branches. 

h. Apply to the Federal Reserve Board for Federal Reserve 
notes to be issued in the manner below indicated. 

§ 4. Federal Reserve notes. In 1914 there were outstand- 
ing about $750,000,000 of what we may now call the old-style 
bank-notes (bond-secured). These were not retired by the 
new act; but the law was shaped with the purpose of retir- 
ing them at the rate of about $25,000,000 a year, so that 
they would all disappear from circulation in thirty years.^ 

s These notes were all secured by the deposit of bonds of the United 
States, a large share of them bearing interest at the artificially low 
rate of 2 per cent. Two per cent, was less than the market rate for 



122 BANKING AND INSURANCE [Pt. II 

Whenever the banks having old-style bank-notes outstanding 
desire to retire any of their circulating notes, the Federal 
Reserve banks may be required by the Federal Eeserve Board 
to purchase the bonds in due quota (not to exceed $25,000,000 
in any one year). On the deposit of these bonds with, the 
Treasurer of the United States, the Federal Reserve banks 
may receive other circulating notes (essentially of the old 
style) called Federal Reserve bank-notes, or may receive 
3 per cent bonds not bearing the circulating privilege. 

The new kind of notes provided by the act are called Fed- 
eral Reserve notes. They are not secured by the deposit of 
government bonds, but they are secured beyond all question 
in other ways. First, they are obligations of the United 
'States receivable for all taxes, customs, and other public 
dues, and redeemable by the latter in gold or in lawful money 
(which includes greenbacks, Treasury notes, gold certificates, 
and silver dollars). Thirdly, their credit and prompt re- 
demption is insured by certain elastic rules as to re- 
serves in gold which must be kept for the redemp- 
tion of outstanding notes. Fourthly, they are secured 
by collateral, consisting of notes and bills accepted for re- 
discount from member banks, which must be deposited by a 
Federal Reserve bank with the Federal Reserve agent of its 
district, dollar for dollar for every note it receives. Fifthly, 
the notes become ' ' a first and paramount lien on all the assets 
of the bank." This is what gives the notes their character 
of asset currency. It is apparent that the notes unite in a 
manner without example the characteristics of asset bank- 
notes with those of political paper money.* 

government loans, for 3 per cent bonds without this privilege sold 
above par. Therefore these 2 per cent bonds were held almost exclu- 
sively by banks, and would have lost a good share of their value had 
the note-deposit privilege been withdrawn. 

4 The Act does not explicitly say by whom the notes are issued: it 
says that they are "to be issued at the discretion of the Federal Re- 
serve Board"; that "the said notes shall be obligations of the United 
States." Further on the notes are spoken of as "issued to" a Federal 



Cu. 9] 



THE FEDERAL RESERVE ACT 



123 



Notes, it will be observed, are issued only on request of a 
Federal Reserve bank, and not by or on request of the mem- 
ber banks. After the notes have been issued, the bank may re- 

'^"■* Federal Res erve Note Circulation '*'••* 

-3500 



3500- 
3000 
2500 
2000 
1500- 
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Fig. 2, Chapter 9, shows the steady' rise of Federal Reserve note 
circulation by months until the latter part of 1920, a level for several 
months as credits began to be curtailed, and a fall beginning the first 
of 1921. 

duce its liability anj- day by depositing lawful money with 
the Federal Reserve agent, who is right there in the bank. 
The Federal Reserve banks and the United States Treasury 

Reserve bank, and again as "issued through" a Federal Reserve bank, 
but not hy it. But the phrase occurs (sec. 16), "its [i.e., the Federal 
Reserve bank's] Federal Reserve notes." The notes thus are technically 
issued by the United States, but not as ordinary political (fiat) money, 
for they are not given a forced circulation by the government in pay- 
ing its indebtedness. But the banks "shall pay such rate of interest 
on" the amounts of notes outstanding as may be established by the 
Federal Reserve Board (i.e., to the government of the United States). 
Practically the notes (as respects choice of time of issue, amounts, 
profits from them, commercial assets to secure them and to redeem 
them) are asset currency issued by the several Federal Reserve banks. 



124 



BANKING AND INSURANCE 



[Pt. II 



must promptly return to the banks through which they were 
issued all notes as fast as tney are received, and "no Federal 
Reser^^e bank shall pay out notes issued through another on 
penalty of a tax of ten per centum." This regulation does 
not apply to the member banks, but its effect must be to keep 
notes from circulating long in any district except that for 
which they were issued. 

§ 5. Reserves against Federal Reserve notes. The rule 
applying in normal times to reserves against note issues is that 
each bank must provide a reserve in gold equal to 40 per cent 
"against the Federal Reserve notes in actual circulation, and 
not offset by gold or lawful money deposited with the 
Federal Reserve agent." At least 5 per cent is to be on de- 
posit in the Treasury of the United States. The proportion 
of reserves to the liability for note issues by any bank, how- 
ever, may be allowed to fall below 40 per cent, on condition 
that the Federal Reserve Board shall establish a graduated 
tax of not more than 1 per cent per annum (it evidently might 
be made less if the Board chose) upon such deficiency, until 
the reserves fall to 32^/^ per cent and thereafter a graduated 
tax of not less than II/2 per cent on each additional 2i/^ per 
cent, deficiency or fraction thereof.^ 

This tax must be paid Ly the R'^serve bank, but it must add 
an amount equal to the tax to the rates of interest and dis- 

5 This may be shown in the following table: 



When reserves against 


notes 


the tax rate upon the total 


are — 






deficiency shall be — 


Below 40.0 to 32.5 


per 


cent 


1.0 


per 


cent 


32.5 to 30.0 


" 


" 


2.5 


" 




30.0 to 27.5 


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27.5 to 25.0 


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Ch. 9] 



THE FEDERAL RESERVE ACT 



125 



count charged to member banks. The effect of these rules is 
to give a power of note issue in time of emergency without 
compelling the Reserve banks to lock up their reserves held 
against notes. Suppose, for example, that the circulating 
notes were in normal times $1,000,000,000, and the reserves, 
therefore, were $400,000,000, and the rate of discount 5 per 
cent. Then the circulation might be doubled with the same 
reserves, the proportion thus falling to not less than 20 per 
cent of outstanding notes, and the rate of discout to cus- 
tomers rising to 13.5 per cent (5 plus 8.5). Or, to take a 
most extreme supposition, suppose that the withdrawal of 
gold had been so great as to reduce the reserves against notes 
to $50,000,000 ; yet outstanding notes might still be doubled, 
becoming $2,000,000,000, the proportion of reserves falling to 
2.5 per cent, the rate of discount rising to 24 (5 plus 19). 



100 
9 3- 
9 
8 5- 
8 0- 
7 5- 
7 
6 5- 
60- 
5 5 
5 0- 
4 5- 
4 0- 



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DERAL Reserve Banks 
Reserve Pecentage 



J5- 
1914| 



I War [ Period | 



1915 



1916 



1917 



1918 



1919 





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- 95 




■90 




•85 




-80 




-75 




-70 




■65 


i 


■60 

■55 


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■45 




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9.20 192 


- 3S 



Fig. 3 sliows the changes in the reserve percentages of the 
the twelve Federal Reserve banks, combined, in the first seven years. 
It was above 80 until 1917, and about 90 in April just as we entered 
the war. It fell to about 55 in the war period, where it remained 
until the latter part of 1919, and fell to 40 the first half of 1920, the 
period of greatest speculation and highest prices. The reserve of some 
of the banks fell several points below 40. (The average reserve re- 
quirement against notes and deposits together was about 38.) Recall 
this chart when considering §§ 11-13 below. 



126 BANKING AND INSURANCE [Pt. II 

§ 6. Reserves against Federal Reserve bank deposits. 

Every Federal Reserve bank shall, under normal conditions, 
maintain reserves in lawful money of not less than 35 per cent 
against its deposits. But the Federal Eeserve Board may 
suspend any reserve requirement in the Act for a period not 
exceeding thirty days and from time to time renew the sus- 
pension for periods not exceeding fifteen days; but in that 
case it must establish a graduated tax upon the amounts by 
which the reserve requirements may be permitted to fall be- 
low the levels specified as to note issues. Although the 
amount of the tax on the deficiency of reserves against de- 
posits is not indicated in the act, it is plainly the thought 
that the Board will follow somewhat the same rule as in re- 
spect to excess note issues. The great discretionary power 
as to reserve requirements thus lodged in the hands of the 
Board makes possible at times of emergency the use of the 
reserves both of the Reserve banks and of the member banks, 
down to the last dollar, if need be, without violation of law. 
This gives practically unlimited opportunity to expand credit 
both by the issue of bank-notes and by discount and deposit in 
periods of financial crises. 

§ 7, Reserves in member banks. Important changes were 
made in the rules as to the reserves against deposits that 
had been in force under the old national banking system. 
A new distinction was made between time and demand de- 
posits. Time deposits are defined as those payable after 
thirty days or subject to not less than thirty days' notice; 
and demand deposits as those payable within thirty days. 
In every case the reserve requirement against time deposits 
is now only 3 per cent (first 5 per cent, but later amended). 
This gives encouragement to banks to maintain savings de- 
partments and to make agricultural loans. The Federal Re- 
serve banks take the place of the banks in reserve and cen- 
tral reserve cities as the depositories of funds that were® 

6 The complete application of the new rule was deferred for a period 
of three years from the passage of the act. 



Ch. 9] THE FEDERAL RESERVE ACT 127 

counted as a part of the reserves of member banks. The 
legal minimum reserves for country banks (as fixed by amend- 
ment June, 1917) is 7 per cent; for banks in reserve cities 
10 per cent; for banks in the three central reserve cities 13 
per cent, all of which must be kept in the Federal Reserve 
bank, till-money not being counted as part of the reserve." 

These legal requirements as to proportion of reserves, as 
compared with those of national banks under the old law, 
are smaller by 53 per cent, 60 per cent, and 48 per cent, re- 
spectively (though practically less reduced because till-money 
is no longer counted). The large increase in lending power 
thus given to the member banks explains in part the large 
expansion of banking credit between 1915 and 1920, the en- 
couragement of speculation in 1918-1920, and the large earn- 
ings of most member banks. ^ 

§ 8. Rediscounts by Federal Reserve banks. IMore im- 
portant than any other single feature of the act is that by 
which each Federal Reserve bank is to rediscount notes, 
drafts, and bills of exchange arising out of actual com- 
mercial transactions, when endorsed and presented by any 
of its member banks. This, quite apart from the note issues, 
gives a power to the banks collectively, under the general 
supervision and control of the board, to expand credits in- 
definitely at any time for real business purposes. This en- 
ables any business man who can offer commercial paper of 
sound quality to borrow on it at some rate of discount, even 
in the most stringent times. And, in turn, every member 
bank should be able at such times to rediscount such paper 

7 By amendment, September, 1918, banks in outlyinfr districts of 
central reserve cities, or of reserve cities, may. by affirmative vote 
of five members of the Federal Reserve Board, be permitted to hold 
reserves less than the usual 13 and 10 per cent, respectively. 

8 Tlie original act reduced the legal minimum of reserves required 
of each of the three classes of banks to 12. 15, and IS respectively, 
and laid down an over-ingenious riile for the proportion that must 
l)e left in the member bank's own vaults and in the Federal Reserve 
Bank, respectively, or that might be in either place. 



128 



BANI^ING AND INSURANCE 



[Pt. II 



and thus secure credit toward its reserve requirement on the 
books of its Federal Reserve bank. Suppose, for example, 
that a member bank (in a central reserve city) saw its re- 
serve in the Federal bank fall below 13 per cent of its de- 
mand deposits. It could by rediseounting $13,000 worth of 
notes increase by $100,000 the amount to which it might 
legally extend credit to its customers. The deposits of the 
Federal Reserve bank would then be increased $13,000, 
against which it must have a reserve of 35 per cent or 



Bil.S 

4.5 

4.0 
3.5 
3.0 
2.5 
2.0 
!.5 
1.0 
.5 
.0 



Reserves Deposits 

AND 

F.R JVoTE Circulation 
1914-1920 



^ 




,_,*i»-» Bil.S 

4.5 

4.0 
3.5 
3.0 
2.5 
2.0 
1.5 
1.0 
.5 



1914 



Fig. 4, Chapter 9, shows the growth of the deposits and note cir- 
culation of the Federal Reserve banks during the war period, and their 
continued expansion after the end of the war. This caused the "free 
gold" (the margin of gold above the legal minimum requirements) to 
decrease until the middle of 1920. This was getting nearer and nearer 
to the point where discount rates must legally be raised (in some dis- 
tricts the point was passed), and finally compelled a contraction of 
credit, which then came quickly and violently. 

$4550. If the reserves of any Federal Reserve bank fall 
too low, it can in turn rediscount its paper with the other 
Federal Reserve banks.® If the time comes when no one of 
the twelve banks can longer maintain a 35 per cent reserve 

9 See on "piping" provision, § 2, above. 



Ch. 9] THE FEDERAL RESERVE ACT 129 

the Board may reduce or suspend the requirement, levying 
a tax graduated according to the deficiency. The provision 
here for elasticity of credit, combined with union and solid- 
arity of all the central banking reserves of the country to 
meet unusual demands in emergencies, exceeds any needs that 
can be expected to arise. 

§ 9. Changes in national banks. There was thus created 
a national system of reserves, but it will be observed that 
membership in the new system of the Federal Keserve banks 
was not limited to national banks, but was opened on equal 
terms to banks organized under state laws. "While in most 
respects the general banking law remained as it was, cer- 
tain changes of importance were made. The percentage of 
reserves required of all member banks (as above indicated) 
is a substantial reduction of the former requirement for na- 
tional banks. In some other respects the powers of national 
banks were enlarged. One with a capital and surplus of 
$1,000,000 may with the approval of the Board establish 
foreign branches, and one not situated in a central reserve 
city may lend on farm-lands for a term not longer than 
five years, but not to exceed one third of its time deposits 
or 25 per cent of its capital and surplus. National banks may 
now be granted permission by the Board to act as trustee, 
executor, administrator, or registrar of stocks and bonds, 
thus having the rights that have proved in many cases to be of 
advantage to trust companies organized under state laws. 

§ 10. Operation in the pre-war period. Nearly a year 
was spent preparing for the opening of the Federal Reser\^e 
banks. The organization committee, after holding meetings 
in many cities, divided the country into twelve districts. 
Officers and a staff of employees had to be selected for each 
of the twelve banks, part of the capital had to be paid in, 
bank buildings and equipment had to be secured, and many 
details arranged. 

It was fortunate that the district banks were nearly ready 
to begin operations when, August 1, 1914, the great European 



130 BANKING AND INSURANCE [Pt. II 

war broke out. The able appointees to the Federal Reserve 
Board commanded the confidence of the bankers and of the 
public. The knowledge that the system would early begin 
to function was reassuring in the grave financial stress of 
the next three months, and the opening of the district banks 
November 16, 1914, at once made possible the release for 
commercial uses of cash reserves and credits to meet the needs 
of reviving business.^" 

The history of the Federal Reserve system for the first 
seven years of its operation may be divided into four periods : 
(1) the pre-war period, from the opening of the banks till 
our entrance into the war on April 6, 1917 ; (2) The war- 
time period, till the armistice, November 11, 1918; (3) the 
post-war period of expansion to May 1920 ; the period 
of falling prices and contraction thereafter (not yet ended 
at this writing). 

Two years and nearly five months elapsed from the open- 
ing of the banks until the United States entered the war. 
This period was filled with work of organization, redistricting, 
preparation of rules and regulations, development of plans 
for the clearing of checks between Federal Reserve banks 
and between member banks, and the admission of state banks 
(a few of which entered the system) . Growth was steady but 
slow up to April, 1917. A general idea of the development 
of the system can be gained from a study of the charts show- 
ing some of the more important statistical data. Federal 
Reserve notes were issued to the amount of $36,000,000 and 
net deposits were $707,000,000, making $113,000,000 total 
liabilities against which reserves must be held; whereas the 
reserves held equaled 89 per cent of liabilities. For several 
months before our entrance into the war the system increased 
the reserve percentages, absorbing some of the gold that was 
flowing into the country and, consequently, reducing some- 
what its "earning assets," which fell to $168,000,000. 
Little use had as yet been made by member banks of the re- 

10 See § 7 above. 



Ch. 9] THE FEDERAL EESERVE ACT 131 

discount privilege, because, as the new legislation had re- 
duced their own reserve requirements, they had "plenty of 
slack" lending power, which only gradually had begun to be 
taken up. Nevertheless, all of the Federal Reserve banks, 
before the end of 1916, had earnings in excess of expenses, 
and one after the other began to declare dividends and to 
increase their surpluses, to the surprise of many who had pre- 
dicted that this would not be possible. 

§ 11. Operation in the war period. With our entrance 
into the war the Federal Reserve system, and our banking 
institutions altogether, entered upon a growth that has been 
characterized by the Federal Reserve Board as "in many 
ways the most remarkable in the financial history of the 
world." At the beginning of the period the volume of busi- 
ness at the Federal Reserve banks was too limited, while the 
available resources of member banks were too large to enable 
the Federal Reserve institutions to exert more than an in- 
cidental influence upon credit uses. The period of belliger- 
ency changed tliese conditions, and at its close the Federal 
Reserve banks stood as the holders of nearly th? entire re- 
serves of the country, the directors of the one unexhausted 
reservoir of banking credit in the world.^^ The Federal 
Reserve system began at once to act as the fiscal agency of 
the government, and continued throughout the war period 
and the post-war period, including the fifth (or Victory) 
loan, to fill the central role in fiscal operations. During this 
period the net deposits of tlie system increased 2i/2-fold, the 
notes in circulation increased 7-fold, and earning assets in- 
creased 14-fold. Paper admissable under the rules for re- 
discount, especially that based on governmental securities, 
which were given preferential treatment and rates, increased 
greatly in amount. Member banks made use extensively of 

11 Paraphrased from editorial statement in the "Federal Reserve Bul- 
letin," Dec. 1, 1918, p. 1164. 



132 



BANKING AND INSURANCE 



[Pt. II 



3.3- 

3.0- 

2.7- 

2.4- 

2.1- 

1.8- 

1.S' 

1.2- 

.9 

.6 

.3- 



ExRNiNG Assets op 

FEDERALltESERVE BaNKS 
1914-1920 




10141 1915 1 1916 I 1917 I 1Q18 1 I9J9 



Fig. 5, Chapter 9, shows the rapid growth of earning assets of the 
Federal Reserve bank during the war period, from barely more than a 
tenth of a billion dollars to over two billions at the date of the armi- 
stice. Observe that after the war, as the member banks availed them- 
selves freely of the rediscoiuit privilege, the total rediscounts rose ra- 
pidly by more than another billion, despite the decrease of war paper. 
The "other discounts," which meant commercial loans, must be looked 
upon as in large part the cause of the commercial speculation, "profit- 
eering," and inflated prices, which marked the period from the middle 
of 1919 to the middle of 1920. 

the rediscount privilege, and took the proceeds, either in notes 
or in credit, to their reserves, this being a source of large 
earnings for the Federal Reserve banks. The accompanying 
table shows the net earnings by years: 

Net Earnings of Fedeeal Reserve System 

Net earnings of capital Per cent 

of 1915 $516,116 

1916 2.750,999 5.0 

1917 11,202.992 18.9 

1918 55,446,979 72.6 

1919 82,038,785 98.2 

1920 151,408,031 160.7 



Nov., 1914, to end 
Calendar year 



Ch. 9] THE FEDERAL EESERVE ACT 133 

§ 12. Gold hoards and artificial interest rates. The war- 
time influence and activities of the Federal Reserve Board, 
and of those controlling the various district banks in general, 
merit high praise. They steadily urged the sound economic 
policy of industry, thrift, and self-denial on the part of the 
people. They fostered no illusions that the magic of bank- 
ing credit or of paper money could take the place of real 
production of the goods needed, and of real abstaining from 
the goods not needed, for the prosecution of the war. Al- 
though the banks (district and member) found it necessary to 
take and hold for a time an increasing proportion of the 
successive loans ("war paper"), and the local banks to lend 
heavily at low rates of interest to customers on the security of 
war paper, great efforts were made to get the public to pay 
in full and to relieve the banks of this burden. 

In two particulars the policy of the Board is more open 
to question. The Board showed a mercantilist bias in favor 
of an artificial heaping up of gold in this country, as shown 
in its fathering and defense of the gold embargo. It de- 
fended this on the ground, first, that it was desirable to con- 
serve the available gold supply on the assumption that this 
would make the country stronger economically. But this 
could but have the effect, in the end, of artificially inflating 
our prices at home, of increasing the amount of Liberty bonds 
to be issued, and of causing the value of the American dol- 
lar to depreciate in the countries from which at the time 
we were buying in excess of our sales. The Board thus con- 
tradicted its own sounder doctrine that goods, not artificial 
inflation of credit and prices, was what was needed to win 
the war. The Board further attached undue importance to 
maintaining low interest rates artificially at a time when the 
natural trend of rates was upward. This could but en- 
courage the increased use of credit by the public, and thus 
neutralized the Board's own sound policy of keeping down 
the use of credit for purposes less urgent or of a speculative 
nature. Throughout the war period (and for a full year 



134 



BANKING AND INSURANCE 



[Pt. II 



thereafter) our banking practice was in violation of tlie 
basic principle of central rediscount, "well established in the 
tradition of Europe, that the official rate of rediscount 
should be above the market rate." 




INDEX NUMBERS OF MONETARY CIRCULATION, 
BANK DEPOSITS AND WHOLESALE PRICES 
FIVE YEAR AVERAGE,19I0-I914 = 100 



Fig. 6. Chapter 9. The increasing wholesale prices appear to be even 
more nearly parallel with the rapidly expending bank deposits than 
with the monetary circulation. 

§ 13. The post-war period. At the sudden termination of 
military operations, the Federal Reserve Board at onee gave 
expression to wise warnings against the inflation and specula- 
tion that usually have occurred at such a time. It declared 
the immediate problem to be that of ''preventing credit from 
expanding too far, and so far as practicable of reducing any 
excess that already exists." It again counseled thrift and 
the acceptance of falling prices by the people, and limitation 
of credits by the banks. If this policy could have been made 
effective, the price index of armistice month (which was 206) 
might have been the peak, and prices might have moved 



Cii. 9] THE FEDERAL RESERVE ACT 135 

slowly downward to lower levels. As it was, prices wavered, 
fell as low as 197 in Febriiar}^ 1919, rose again, then with 
a bound went up in July, 1919, to 219, and still upward to the 
peak of 272 in May, 1920, then to plunge steeply down- 
ward to 151 in May, 1921. Enormous evils of speculation 
and undeserved profits to some, unjust burdens of rising 
prices to many others, great waste of productive effort, and 
finally much unemployment and suffering in the period of 
crisis, would have been avoided if the price readjustment 
downward had progressed evenly from the date of the armis- 
tice. 

To fix the blame precisely is not easy, or indeed possible; 
but a large part of it must be traced back to the policy of 
the United States Treasury in fixing the rate of interest on 
all its issues of loans artificially below the market rate. 
As a result the bonds had to be marketed more by appeals to 
patriotic motives, enforced bj- many measures of popular 
coercion to induce and compel the public to subscribe to the 
loans, and still further supported by preferentially low in- 
terest rates by member banks to enable customers to carry 
bonds on bank loans, and preferentially low rediscount rates 
on such paper presented for rediscount at the Federal Re- 
serve banks. At one time the total of war paper held by 
all banks (including the Federal Reserve), exceeded $6,000,- 
000,000, and the very preference given to it for rediscount 
was a premium to active business not to pay off the loans 
but rather to use funds for other purposes in a period of 
rapidly rising prices. The Treasury and the Federal Re- 
serve banks, in this policy of artificially low interest rates, 
had "caught a Tartar," and did not know how to let go 
without causing a slump in the price of Liberty bonds, which 
nevertheless was sure to occur. The 414 per cents (wiiich 
composed the larger part of those outstanding) fell some- 
what below par early in 1919, fell to 92 in December, 1919, as 
discount rates and rediscount rates were raised, and as low 
as 82 in May, 1920. Large quantities of the bonds appear 



136 BANKING AND INSURANCE [Pt. II 

to have been thrown upon the market by holders who had 
been carrying- them on credit. The whole policy above dis- 
cussed must be looked upon as a case of price-fixing by 
which the rate of interest on government loans was kept 
artificially lower through an unsound use of government con- 
trol over banking policy. The results were speculation, infla- 
tion of prices, and eventual disillusionment and loss to in- 
vestors and to large numbers of other citizens. 

§ 14. Future of the Federal Reserve system. The Fed- 
eral Reserve system rendered valuable service during the war, 
and was a stabilizing influence in the period of industrial de- 
pression that began midway in 1920. While there has been 
enormous shrinkage in prices, in valuations of goods in stock, 
in securities, and in "paper profits," and inevitable loss to 
many investors and business men, the ' ' retreat ' ' has been more 
orderly than in previous financial crises, and at no time has 
the banking system as a whole been anywhere near danger 
of collapse, as in former crises. The Federail Reserve banks 
have become an indispensable part of our banking system. 
Probably valuable lessons have been learned from the war- 
time experience. It is probable that the use of the rediscount 
privilege will, in normal times, not be extended to the limit, 
as in 1919 and 1920, but will be kept in large part in reserve 
for emergencies. This would result in smaller earning assets 
and earnings for the Federal Reserve banks, and would make 
the recent figures in these respects appear abnormal, and 
not to be expected regularly. Altogether, as a piece of 
financial machinery, the Federal Reserve system has been 
a demonstrated success, and doubtless is capable of beneficial 
development. However, the possibility of political inter- 
ference with banking policy is apparent, and might become 
a grave danger to the whole financial situation. 

Refeeences. 

Federal Reserve Board, The Federal Reserve Bulletin. Monthly. 
Kemmerer, E. W., The A B C of the federal reserve system. Prince- 
ton. Pp. 192. Princeton University Press. 3d ed. 1919. 



Cii. 9] THE FEDERAL RESERVE ACT 137 

Phillips, C A., Readings in money and banking. Ch. XXXI. N. Y. 

Macmillan. 1916. 
White, Horace, Money and banking illustrated by American History. 

Bost. Ginn. 1914. Bk. III. Ch. XXII and appendices D and 

E. 
Willis, H. P., The Federal Reserve Act. A. E. Rev., 4: 1-24. 1914. 



CHAPTER 10 



CEISES AND INDUSTRIAL DEPRESSIONS 

§ 1. Mischance, special and general, in business. § 2. Definitions. 
§ 3. A feature of a money economy. § 4. European crises. § 5. 
American crises. § 6. A business cycle. § 7. General features of a 
crisis. § 8. The use of credit. § 9. Interest rates in a crisis. § 10. 
dynamic conditions and price readjustments. § 11. Tariff changes and 
business uncertainty. § 12. Rhythmic changes in weather and in crops. 
§ 13. "Glut" theories of crises. § 14. Monetary theories of crises. 
§ 15. Capitalization theory of crises. § 16. Remedies for crises. 

§ 1. Mischance, special and general, in business. Every 
separate business enterprise is subject to chances that sud- 
denly decrease its profits and the prosperity of its owners; 
such are fire, flood, illness of its owners, unfavorable changes 
in prices of materials or of the products.^ The interests of 
many other persons in the neighborhood may be so bound up 
with an enterprise that its losses may mean unemployment, 
lower wages to workingmen, and bankruptcy to local mer- 
chants and to banks. Sometimes misfortune and disaster affect 
whole communities. The lack of cotton while the Civil War 
was in progress compelled the factories of Manchester to 
close in 1864, and the earthquake and fire in San Francisco 
in 1906 left a quarter of a million people homeless. 

But a change of business conditions is constantly occurring 
that is of wider extent, that is of less accidental and of more 
rhythmic nature, and that appears to be the effect of slowly 
working and more general causes. The enterprise of a mod- 
ern community, as a whole, ' ' general business, ' ' moves along 

1 On the way these affect private profits see Vol. I, pp. 340, 341 (and 
references there given in note), 348 ff. and 361 if. There are thus 
good reasons for discussing crises in connection with profits, as well 
as with money and banking. 

138 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 139 

in a wavelike manner, going throngh a somewhat regular 
series of changes that is called a business cycle. We are now 
to study the nature of these cycles. 

§ 2. Definitions. Crisis means, generally, a decisive mo- 
ment or turning point. The word crisis suggests a brief 
period, a moment, something that is sudden, severe, and soon 
over. In medical usage it is the period when the disease 
must take a turn for better or for worse. As used in eco- 
nomics, the term, however, implies a sudden change of busi- 
ness conditions for the worse, a collapse of prosperity. What 
preceeds has not the appearance of disease, but rather that 
of exuberant health. Crises in economics may be distin- 
guished as industrial, speculative, and financial, according 
as one or another influence seems to be more potent, but all 
are essentially financial. The change that occurs always is 
connected in some way with the use of money and credit. 

A financial crisis is that brief period in which the gen- 
eral rise of prices culminates and a general fall begins 
which shatters the credit of some banks, brokers, merchants, 
and manufacturers. Every crisis is marked by much con- 
fusion and loss and by hasty efforts of individuals and in- 
stitutions to meet their pressing obligations. Sometimes this 
process of liquidation goes on quietly; when it becomes a 
wild scramble, each one trying to save himself, it is called 
a financial panic. An industrial depression is the period of 
hard times that usually follows a financial crisis. A husiness 
cycle is the period from one crisis to another within which 
occurs the complete series of price and business changes above 
and below the average. 

§ 3. A feature of a money economy. Financial crises, 
by their very nature, are confined to communities in which 
the money economy prevails and where there is a developed 
state of industry. The periods of industrial hardship in the 
Middle Ages were connected usually not with the collapse 
of prices but with political oppression, famine, wars, pesti- 
lence, and scourges of nature. Throughout the lands money 



140 BANKING AND INSURANCE [Pt. II 

was little used and there was no development of credit and 
of credit prices. The money economy began, as has been 
noted, in the cities. As the use of money spread, as larger 
commercial enterprises were undertaken, as borrowing and 
the payment of interest became common, there began to ap- 
pear in city trading circles, on a small scale, the phenomena 
of the modern crisis.^ 

§ 4. European crises. In Europe financial crises date 
from 1763 and have occurred at more or less regular intervals 
since. The common statement that the cycle of a crisis is 
run in a period of ten years finds only partial support in his- 
tory. The chief crises of the eighteenth century occurred in 
1763, 1783, 1793, these dates marking the close of wars of 
some magnitude. The crises were not widespread or general, 
but were more marked in England, which was at that time 
farther developed industrially and in its money economy 
than other countries. Likewise, thereafter, the crises were 
of unequal force in various European countries, usually be- 
ing more severe in England, where they occurred in 1803, 
1825, 1838, 1847, 1857, 1864-66, 1875, 1890, 1900, 1907, and 
1914. These have been attributed to various causes : that of 
1825 to over-trading abroad; that of 1847 to railroad-build- 
ing; while that of 1864-66 was attributed to the severe 
disturbance of the cotton trade and of commerce by 
the Civil "War in America. While in many parts of 
England the crisis of 1864 was unusually severe, in other 
countries it was of little moment. Germany, after several 
years of great speculative prosperity, had a most severe crisis 
in 1875; while France, although prostrated by the war of 
1870-71, losing a large amount of wealth and paying a thou- 
sand millions of dollars to Germany as a war indemnity, es- 
caped a commercial crisis almost entirely at that time. 

§ 5. American crises. Since the beginning of the nine- 
teenth century the financial connections of the United States 

2 See Vol. I, pp. 51, 154, 300-302. 



Cir. 10] CRISES AND INDUSTRIAL DEPRESSIONS 141 

with London, the leading loan market of Europe, have been 
such that every crisis in either England or America has 
extended its effects to the other country. But the disturb- 
ances are so modified by the particular conditions (of crops, 
politics, and speculation) that the phenomena never corres- 
spond exactly in time of occurrence, in duration, or in in- 
tensity. The first notable crisis in America occurred about 
1817 in the very violent readjustment of trade after the re- 
sumption of commerce with Europe in 1816.^ In 1837-39 
came in quick succession two crises, not quite distinct from 
each other, the second similar to the relapse of a fever 
patient. The conditions were rapid westward expansion, over- 
speculation in lands, reckless state internal improvements, 
great issues of state bank-notes, and the financial measures 
of Andrew Jackson, which included the dissolution of the 
Second Bank of the United States in 1836.* The crisis of 
1857 followed a period of great prosperity marked by rising 
gold production and prices and a great increase in foreign 
trade. The crisis of 1873, possibly the severest in our his- 
torj^, followed great speculation, especially in the direction 
of railroad-building on an unexampled scale after the war. 
The blow, when it fell, was intensified by the relative con- 
traction of currency then in progress, leading to the return 
to a specie basis and lower prices.^ The crisis of 1884, a com- 
paratively slight one, occasioned (rather than caused) by the 
discussion of the money question, was followed by soDie years 
of noticeable depression. The years 1889 to 1892 witnessed 
prosperity, only slightly inten-upted in 1890, that culminated 
in a crisis in May, 1893 (likewise generally explained as due 
to the unsettled state of our monetary system), followed by 
a period of great depression lasting until 1897. A rapid 
growth of business in America was checked but little in 1900, 
when a crisis was occurring in Europe, especially severe in 

8 See ch. 14, § 6, on the tariff legislation at this time. 

4 See ch. 8, § 1. 

5 See ch. .5, § 8. 



142 BANKING AND INSURANCE [Pt. II 

Germany. In November, 1902, beg:an in America what has 
been called the "rich man's panic" of 1903, in which for a 
year many securities were sold by holders probably because 
European creditors were recalling their loans. Although 
building operations were somewhat checked, American busi- 
ness slackened but little. General prices, which had been 
moving upward since 1897, remained almost unchanged in 
1903 and 1904, and then continued upward until 1907. In 
the period from September to November of that year occurred 
a severe crisis both in Europe and in America. The indus- 
trial depression following this was marked in 1908, slowly 
growing less. The crisis at the outbreak of the war in 
August, 1914, was quite exceptional, being due to the sudden 
demand of Europe upon New York for funds. Within a 
couple of months it was over, and soon prices were again 
rising as the result of large exports of merchandise followed 
by gold imports. 

The rise in war prices, slightly checked at the beginning 
oP 1919, reached its peak in America, as we have seen," in 
May, 1920, and within about a month of the same time in 
most of the leading countries. The average fall of whole- 
sale prices in the next year (from 272 to 151) was the 
most rapid that has ever been experienced in America. 

§ 6. A business cycle. Let us now sketch in broad out- 
line a business cycle bearing in mind that this series of 
changes does not repeat itself with unvarying regularity, 
but that it is fairly typical in the modern business world. 
The period leading up to a crisis is one of relative prosperity ; 
then occurs a crisis in which prices fall, at first rapidly, and 
afterward for a while going slowly lower. When prices 
are at the lowest point many factories are closed and much 
labor is unemployed. Let us start at that point. Conditions 
are worse in some industries than in others. General econ- 
omy and great caution prevail; few enterprises are under- 

« See ch. 6, § 9; ch. 9, § 13. 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 143 

taken. For those persons having available funds this is a 
good time to buy, and property begins to change hands. 
Then hoarded money begins to come out of its hiding-places. 
IMoney and credit flow in from other countries, particularly 
if business conditions are better abroad than here, for when 
prices are lower than they have been, relative to those of 
other countries, a country is a good place in which to buy. 
At the same time that the money in circulation thus increases, 
there is a general return of confidence that increases credit. 
Not only are there more dollars, but each does more work. 
Then old enterprises are resumed and new ones are under- 
taken. The purchase of materials in larger quantities causes 
a rapid rise in the prices of many raw materials and of 
all kinds of industrial equipment. The less efficient laborers 
and others that have been out of work begin to find employ- 
ment, and then, more tardily, wages begin to rise. As a 
result, the costs of many products begin to rise rapidly. The 
only classes not sharing in this improvement are the receivers 
of fixed incomes. As prices rise, the purchasing power of 
their incomes correspondingly falls. 

At length prices begin to go up less rapidly, and the ques- 
tion arises in many minds whether the movement can con- 
tinvie, and if not, when it will cease. Men wish to hold 
on for the last profits, and are willing to risk something to 
gain them. When prices rise not only as compared with 
former domestic prices, but as compared with current foreign 
prices, foreign imports are stimulated and exports fall. This 
calls for a new equilibrium of money, and requires at length 
large and continued exportation of specie. This checks 
prices, and, reducing the specie reserves of the banks, com- 
pels them to be more cautious. At the same time the increase 
of costs in many industries begins to reduce profits. The 
fall in the value of many stocks and securities held by the 
banks forces many brokers and speculators to convert their 
resources into ready mone3^ This is the moment of danger; 
weak enterprises find their foundations crumbling, and there 



144 



BANKING AND INSURANCE 



[Pt. II 



are many failures.'' The falling prices, the shattered credit, 
and the financial losses force many factories to close, and 
many workmen are thrown out of employment. This period 
of beginning collapse is the crisis. It is followed by another 
period of low prices and of small output, and therefore of 
profits small or negative in many industries. Business must 
again enter upon a period of retrenchment, for it has com- 
pleted another cycle. 




1S10 16^0 1830 1840 1650 letO 1870 1680 1690 1900 1910 m.Q 



Fig. 1, Chapter 10 shows the great similarity in the changes of gen- 
eral prices in England and in the United States from 1790-1920, both 
in respect to the larger movements and levels, and to the minor fluctua- 
tions. It shows also that this relationship has become much closer 
since 1870. See also Figure 1, Chapter 5. 

§ 7. General features of a crisis. Although irregular in 
time of occurrence and unlike in their immediate occasions, 
financial crises show certain general features. They are a 
part of the larger movement here outlined as the business 
cycle. Some have thought this cycle to be normally a period 
of ten years, divided into one year of crisis, three years of 
depression, three years of recovery, and three years of un- 
usual prosperity. This succession of events occurs pretty 

7 See diagram of business failures, 1890-1914, in Vol. 1, p. 364. 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 



145 



regularly, though not in the regular intervals of time. Crises 
are more severe in countries with more extensive use of 
money and credit, but still more severe where the credit 
system is more loosely administered and less efficiently co- 



BUSINESS 

CrcLES 



Bank Reiervei 

Bank Loans 
(,nf/af,on) 

Bank C/fanngs 
Stock Pr/ces 




(Bank Reservei) 



-I l_a I I i_ 



Fig. 2, Chapter 10, on Business Cycles, shows the rhythmic movement 
tliat occurs in various business and financial conditions. Taking the 
curve of commodity prices as the central fact, it is seen that its peak 
has been preceded in time successively by peaks of bank reserves, 
loans, and clearings, and by stock prices (which always speculatively 
anticipate higher dividends) and is soon followed by declining divi- 
dends, by the peak of discount rates, and by failures; tlien bank re- 
serves gradually being built up, the cycle is repeated. This diagram, 
Iiitherto unpublished, was prepared by Professor G. R. Davies, Univer- 
sity of North Dakota, to whose courtesy we are indebted for permis- 
sion to use it here. The data are plotted so as to show the variations 
above and below the averages, eliminating the absolute growth due 
to increasing population, business, etc. 



146 BANKING AND INSURANCE [Pt. II 

ordinated. As a rule they have been harder in the United 
States and England than in Germany, harder in Germany 
than in France, harder in western Europe than in eastern 
Europe, harder in Christendom than in heathendom. They 
are less severe in rural districts, where prosperity depends 
more on crop conditions and business has in it less of finan- 
cial speculation. Their effects are least felt in the staple in- 
dustries, for when hard times come people economize on the 
less essential things. The glove factory, the silk factory, the 
golf-club factory are more likely to close than is the flour- 
mill. In a crisis wages and salaries are less quickly affected 
than are profits, but wageworkers suffer in the loss of employ- 
ment. Those money-lenders who have eliminated chance as 
far as possible and have taken a low rate of interest lose 
little ; the risk-takers who draw their incomes from dividends 
on stock or from bonds of a less staple kind often lose much. 
§ 8. The use of credit. The general use of credit is, as 
we have observed, an essential condition to the occurrence 
of a financial crisis, so that, indeed, a crisis might be called 
a disease of the credit system. The use of credit greatly en- 
hances the rhythm of price. If the value of a thing that is 
fully paid for falls, the owner alone loses ; but if the value of a 
thing only partly paid for falls so much that the owner is 
forced to default in his payment, the loss may be transmitted 
along the line of credit to every one in a long series of trans- 
actions. A credit system, highly developed, is a house of 
cards at a time of financial stress. Demand liabilities are 
at such a time the greatest danger, so that the banks, ordi- 
narily the pillars of financial strength, become at such a time 
the points of greatest weakness in the financial structure. 
If many of the customers were not restrained by their sense 
of personal obligation to the banks, by the strong pressure 
that the banks can bring to bear upon them, or by the force 
of public opinion among business men, from withdrawing 
the balances to their credit in a time of crisis, all commercial 
banks would become insolvent at once in a crisis by the very 



Cii. 10] CRISES AXn INDUSTRIAL DEPRESSIONS 147 

nature of their business; for all their ordinary deposits are 
nominally payable on demand. 

§ 9. Interest rates in a crisis. In normal times there is 
always outstanding a great mass of short-time commercial 
loans.^ The motive of the borrower, in most cases, has been 
to hire more labor and to buy more materials for use in his 
business. Ordinarily these loans can and are renewed with- 
out difficulty, or are replaced by others, based on the security 
of new business transactions in unbroken succession. Now, 
at the time of a crisis a general contraction of credit occurs, 
and borrowers with maturing obligations would face bank- 
ruptcy if they could not renew their loans. The effort of 
the business man at such a time is not to make a positive 
profit, but to save what he can from the threatened wreck. 
The demand for short-time loans, therefore, in such times of 
stress, fluctuates rapidly, and exceedingly high interest rates 
may prevail in these loan markets for a few days or a few 
weeks, rates that have only a remote relationship with the 
usual capitalization of most agents. 

The distress of the business man is magnified ,by the fact 
that it is at just such times that both the equipment he has 
bought and the products he has made become temporarily 
almost unsalable at prices as high as he paid for them when 
he bought them with the borrowed money. He may know 
that prices will soon be higher, but he cannot wait. Various 
courses are open to him in this emergency: he may borrow 
the money at a very high rate of interest, holding the goods 
for better prices ; or he may sell the goods under the unfavor- 
able conditions; or he may sell other capital such as stocks 
and bonds. The end sought is the same — to get ready money ; 
and the methods are not essentially unlike — the exchange of 
greater future values for smaller present values. The sacri- 
fice sale thus reveals the merchant's high estimate of present 
goods in the form of money. The purchaser of some kinds of 

8 See Vol. I, p. 304. 



148 BANKING AND INSURANCE [Pt. II 

property in times of depression is securing them at a lower 
capitalization than they will later have. The rise in value 
may be foreseen as well by seller as by buyer, but the low 
capitalization reflects the high interest rate temporarily ob- 
taining. A. T. Stewart, once the most famous New York 
merchant, is said to have laid the foundation of his fortune 
when, being out of debt himself, he bought up the bankrupt 
stocks of his competitors in a great financial panic. The high 
interest at such times is but the reflection of the high premium 
on present purchasing power. 

The worst of the evils of crises are confined to the markets 
where the greatest numbers of short-time loans are made. 
Most of the long-time loans do not fall due in such seasons 
of stress, and the great mass of slowly exchanging wealth 
alters little and slowly in price. Such long-term loans as 
fall due can generally be renewed at rates little higher 
than usual, the market for long-time and short-time loans be- 
ing in large measure independent of each other. But they are 
not quite independent, and some lenders take whatever sums 
they can collect on maturing long-time obligations and lend 
them on short terms at high rates of interest, or buy goods, 
whole enterprises, bonds, and stocks, at the unusually low 
prices temporarily prevailing. The effect of this is to raise 
somewhat the interest rate on long-time paper to accord with 
the new conditions. 

§ 10. Dynamic conditions and price readjustments. A 
condition favorable to large and rapid shifts in prices and 
credits is a dynamic economic society. The past century has 
opened up new fields for investment on an unexampled scale. 
Investment has advanced both intensively and extensively in 
a series of great waves. New machinery and processes have 
given undreamed of opportunities for enterprise in the older 
countries, and the physical frontier of investment has moved 
outward with the march of millions of immigrants to people 
the fertile wilderness. Such factors disturb the equilibrium 
of prices both in time and space, give a powerful impulse 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 149 

toward higher values in the older lauds, and stimulate the 
hopes of all investors. "Wlien the balance between the prices 
and profits in various industries and between the incomes 
of the various periods proves to be false, the inevitable read- 
justment causes suffering and loss to many, but particularly 
in the inflated industries. But, because of the mutual re- 
lations of men in business, few even of those who have kept 
freest from speculation can quite escape the evils. 

Among the dynamic conditions in industry are changes in 
the general price level, whether due to changes in the produc- 
tion of the standard money commodity (relative to popula- 
tion) or to changing methods of doing business. If the price 
level is falling (i.e., the standard unit is appreciating), the 
burden of the great mass of outstanding debts is growing 
heavier upon the debtors. Sooner or later some of them 
break down under its weight. At such times many attempt 
to shift their capital from active investments, such as stocks, 
to passive investments, such as bonds. When the price level 
is rising, the opposite conditions prevail. But such adjust- 
ments proceed uncertainly and unevenly in different indus- 
tries, with much speculation in shifting from one type of 
business to another, and with mucn accompanying miscalcula- 
tion. 

§ 11. Tariff changes and business uncertainty. Another 
variable influence in American business has been the tariff. 
Every tariff revision, whether the rates go upward or down- 
ward, shifts somewhat the relative opportunities and profit- 
ableness of different industries. Some of these call for far- 
reaching readjustments of investments and of productive 
forces. Some persons gain and some lose by every such 
change. It has been contended that a reduction of tariff 
rates has a more disturbing effect upon business than does 
an increase. If this is true it may be because the industries 
injured by a lowering of tariffs in America are those most fully 
within the circle of the credit system; whereas most of the 
consumers adversely affected by a rise of tariff rates are 



150 BANKING AND INSURANCE [Pt. II 

outside the commercial circles where short-time credit is com- 
mon and where the rapid readjustment of investment leads 
to a financial crisis. It never has been convincingly shown, 
however, that there is any large measure of correspondence 
in time (not to say causal relation) between tariff revisions 
and crises.® 

§ 12. Rhythmic changes in weather and in crops. The 
periodic though not quite regular recurrence of crises has 
suggested the thought that they may be causally related with 
some one dominating force such as is found in the conditions 
of nature. The English economist Jevons attempted toward 
the end of the nineteenth century to show statistically a re- 
lationship between financial crises and the variation in sun- 
spots. This idea has usually been treated as whimsical, but 
the continued efforts of physicists to discover a causal 
relation between sun-spots and the weather suggests that a 
real causal relation between the physical and the economic 
phenomena may yet be found. The alteration of seasons 
of poor with seasons of good harvests, "lean years with fat 
years," follows a line strikingly suggestive of the curve of 
the business cycle. Some reasons for this relationship are 
apparent. For example, in America, since about 1865, farm 
products have constituted the larger part of our exports, so 
that a succession of large harvests has usually acted to stimu- 
late exports (one of the features of a period of prosperity), 
to give us a larger credit balance in international trade, 
and to reduce the rate of exchange. Large harvests of the 
staple agricultural crops in America have been shown to be 
closely related to the amount of rainfall in the three most 
important growing months. Recently it has been shown that 
the rainfall of the Ohio Valley occurs in cycles of about 
eight years, and in a larger cycle of thirty-three years, and 
that the cycle of yield per acre of the nine principal crops 
corresponds closely with the cycle of pig-iron production 



9 See on tariff legislation and business crises, ch. 16, § 13. 



J 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 151 

(one of the best single indices of growing business and of an 
upswing in the business cycle) dated from one to two years 
later. There is found what is called in statistics a high 
degree of correlation (.719 in the former and ,800 in the 
latter case), indicating that there is that percentage of proba- 
bility that there is some causal relation between the two 
sets of figures. As the cycles of rainfall and of harvests 
are not coincident in different countries, it will require 
further study to adjust to these observations the fact of the 
world-wide extent of the great financial crises. But a bet- 
ter understanding of objective conditions of this kind will 
give fuller meaning to the interpretation of the financial 
and the psychological features of crises. 

§ 13. " Glut" theories of crises. Many explanations of the 
causes of financial crises have been offered.^° Nearly all of 
these belong to the general group of ' ' glut ' ' theories, of which 
genus there are two species, under-consumption and over-pro- 
duction theories. These are, in truth, but two aspects of 
the same idea.^^ The one view is that too many goods are 
produced, the other that too few are consumed. The over- 
production theorist, seeing that in a crisis warehouses are 
filled with goods that cannot be disposed of for what they 
cost (or at best not so as to give a profit), and that factories 
are shut down and men are out of employment for lack of 
demand, declares that productive power has grown too great. 
The under-consumption theorist, seeing the same facts, says 
that the trouble is lack of purchasing power. He observes 
that there are some people who would like to buy more of some 
of these things, but that such people lack income with which 
to buy. Usually he asserts that this is because production 

10 In the first annual report of the United States Commissioner of 
Labor is given a long catalog of theories that have been suggested, 
many of them quite fantastic. 

ii See Vol. I, ch. 38, on abstinence and production. Believers in the 
glut theory usually condemn efforts to encourage frugality among the 
masses, calling it the "fallacy of saving." 



152 BANKING AND INSURANCE [Pt. II 

grows faster than wages, wages being fixed, as he believes, by 
the minimum of subsistence — a theory akin to the iron law 
of wages. The Marxian socialist's theory of crises is a more 
complex variety of this type, being connected with the ' ' theory 
of surplus value, ' ' in which the capitalist class is conceived of 
as gradually appropriating the surplus value produced by 
the workers until there is no longer enough purchasing 
power left in the workers' hands to purchase the products of 
the capitalists' factories., 

These views have wide vogue, but' they have the same taint 
of illogicalness as the "fallacy of waste" and the "fallacy 
of luxury. ' ' ^- Both in over-production and in under-con- 
sumption theories, the inequality of demand and supply is 
looked upon as a general one. There is supposed to be not 
merely an unequal and mistaken distribution of production, 
but a general excess of productive power. Such theories 
overlook the fact that an income, either of money or of 
other goods, coming even to the wealthiest, will be used in 
some way. It may be used either for direct consumption &t 
for further indirect use in durable form. Through miscalT 
culation there may be, at a given moment, too many coUt 
kumption goods of a particular kind, but the durable applica- 
tions could find no limit until the material world became 
incapable of improvement ; but that day is inconceivable. 
At the time of a crisis, there is unquestioiiably a I) ad appor^ 
tionment of productive agents, and a: still WorSe' adjustment 
of their valuation's, but these facts should riot be takeiL-'as 
proving that ther^ is an excess of all kinds of '^eeJnoiiiic 
goods. . ' / %: • ' - 

^ § 14. Monetary' theories of crises. Another group of 
theories of crises connects them with the supply of money, 
,either too great or too, small. The unreguljated issue of bank- 
notes has been assigned as the cause of crises, especially such 

•as' those of 1837 and 1857 in America, when 'bank-note issues 

« ,■ 

12 See Vol. I, eh. 37, § 6 and § 9. 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 153 

greatly contributed to the unsound expansion of credit. The 
issue of government paper money years before, leading to 
inflation and speculation, was by many believed to be the 
cause of the crisis of 1873. The reverse view is taken by the 
advocates of a cheap and plentiful money. They say that 
these crises were caused, not by the expansion but by the con- 
traction of the money stock ; for example, not by the inflation 
of prices through the issue of greenbacks in 1862 to 1865, 
but by the contraction of the currency from 1866 to 1873. 

There is only a fragment of truth in these variou^s views. 
If it may be said to be ''laqk of money" at the moment of 
a crisis that is the immediate cause of particular failures 
and losses, it is "money"' only in the figurative sense of 
credit and immediately available purchasing power. The 
question is, wliethe'r in any reasonable sense it can be said 
that it was lack of a' circulating medium before the crisis that 
brought it on. There is no support for this view, except 
in the rare ease wlieh the money standard is undergoing a 
rapid change, as in the United States from 1866 to 1873, 
and the statement then needs much modification and explana- 
tion. The monetary theories of crises are a bit nearer to the 
truth than are those of the over-production type, for a 
crisis is always connected with prices and credit. But it is 
clear that these rhythmic price changes occurring in the 
business cycle are not due to the same causes as are the 
general movements of the price level, due to an increasing 
or decreasing output of gold or again to a paper-money in- 
flation. Statistics show that, while a general price level is 
slowly changing like a tidal movement, the effect of the 
rhythmic business cycle appears now in hastening, now in 
retarding, the changes in the price level. 

§ 15. Capitalization theory of crises. Here, as repeat- 
edly above, we verge upon a different type of explanation of 
the crisis — one of a psychological nature. The quantity of 
money, we have seen, affects prices more or less, according as 
credit is more or less used -in connection with it. Money plus 

/ 



154 BANKING AND INSURANCE [Pt. II 

confidence has a larger power of sustaining prices than money 
without, or with less, confidence. And throughout the busi- 
ness cycle the amount of confidence, expressed in such ways 
as the readiness to grant credits and in the easy extension 
of the time of collection, is constantly changing. Over-con- 
fidence at one time is suddenly followed by widespread lack 
of confidence. This has led some to say that lack of con- 
fidence is the cause of crises. This is true, but does not ex- 
plain what is the real cause of this lack of confidence, which, 
when the crisis comes, is not mere unreasoning fear that 
needs only to ignore the danger to banish it. Might it not 
just as truly, if not more truly, be said that the cause is 
over-confidence in the period preceding the crisis? 

The essential characteristic of a crisis is the forcible and 
sudden movement of readjustment in the mistaken capitaliza- 
tion of productive agents. Capitalization runs through all 
industry. The value of everything that iasts for more than 
a moment is built in part upon incomes that are not actual, 
but expectative, whose amount, therefore, is a matter of guess- 
work, or ' ' speculation. ' ' ^^ Many unknown factors enter into 
the estimate of future incomes. The universal tendency to 
rhythm in motion (material or psychic) manifests itself in 
an overestimate or underestimate of incomes and of every 
other factor in value. This is emphasized by a psychological 
factor called sometimes the "hypnotism of the crowd" and 
sometimes the "mob mind." Most men follow a leader in 
investment, as in other things. The spirit of speculation 
grows until often it becomes almost a frenzy, and people rush 
toward this or that investment, throwing capitalization in 
some industries far out of equilibrium with that in others. 

The cause- of crises immediately back of the maladjusted 
capitalization thus is seen to be a psychological factor; it is 
the rhythmic miscalculation of incomes and of capital value, 
occurring to some degree throughout industry, but particu- 

13 See, e. g., Vol. I, pp. 271, 335, 365-367. 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS ir,5 

larly in certain lines. This subjective cause in men is given 
an opportunity for action only when certain favoring objective 
conditions are present. This rhythmic movement as it appears 
in the capitalization of enterprises is favored and magnified 
by the wide use of credit and by the constanth^ changing tech- 
nical and physical conditions of industry. These call for 
constant revaluations of the sources of incomes, thus destroy- 
ing customary and habitual valuations. Some of the new 
dynamic forces, such as inventions and growth of population, 
are distributed pretty regularly along the line, so that their 
influences are nearly equalized. But occasionally some large 
impulse may serve to start a swing, and if this impulse is 
somewhat regularly repeated, it may serve to keep up the 
rhythmic motion. But, the lack of coincidence in the im- 
pact of various influences which occur accidently, such as 
political changes, wars, and the rapid opening of new routes 
of transportation, serve to hasten or to retard, perhaps for 
a time quite to alter, what would otherwise be the rhythm 
of the cycle. 

§ 16. Remedies for crises. The financial crisis must be 
looked upon as an economic disease which brings many evils 
in its train. The need is not merely to mitigate the severity 
of the brief period of crisis, but also to smooth out the curve 
of the business cycle, so as to reduce periodic unemployment, 
the lottery element in profits, and the number of unmerited 
failures in business. Several measures may aid toward this 
end. In the recent past the crisis has been more severe in 
America than in Europe because of certain well-recognized 
defects which now have been ilargely remedied in the Federal 
Reserve Act." The pi'ovision whereby any one may get 
credit on good commercial assets should make it difficult 
if not impossible for a crisis to degenerate into a panic. It 
provides springs to reduce the jolt of the change from a 
higher to a lower level of prices. 

14 See above, ch. 9, §§ 5, 6, 8. 



156 BANKING AND INSURANCE [Pt. II 

Probably other improvements may be made in our banking 
laws. Competent students of tbe subject have urged that the 
payment of interest on deposits not subject to notice before 
withdrawal should be made unlawful, because demand de- 
posits constitute the greatest danger at critical times. In 
principle this objection is sound, though experience may 
show that this evil has been practically remedied by other 
features of the Federal Reserve Act. Moreover, bankers 
could, by pursuing a more conservative policy, discourage 
speculative methods of enterprise. The strong public disap- 
proval of stock-market speculation on margins may some day 
be able to express itself effectively in ways that will not in- 
jure healthy business. Greater stability in our tariff policy 
would remove a constantly disturbing factor in prices, as 
would likewise the stabilizing of the standard of deferred 
payments. In the attempt to remedy the great evil of un- 
employment, public works of every kind might be planned 
and distributed in time so as to better equalize the demand for 
labor and materials. Finally, much better commercial sta- 
tistics are needed, and for collecting them and reporting the 
outlook government organization is required comparable in 
range and methods to the "Weather Bureau. 

It cannot be expected, however, that financial crises, in the 
sense of general readjustments of prices downward from time 
to time, ever can be completely abolished. There will always 
be changes in general industrial conditions calling for re- 
evaluation of the existing sources of income; and in this 
process there will always be a tendency to rhythmic swing 
like that of a river, which carries the stream of prices now 
on this side of the valley, now on that. But this fluctuation 
of general prices surely can be so greatly moderated in mag- 
nitude and in evil results as to make the word "crisis'' almost 
a misnomer. It is toward the attainment of this irreducible 
minimum of uncertainty and disaster in business that efforts 
should be directed. 



Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 157 

References. 

Dewey, D. R., Financial history of the United States, 4th ed. N. Y. 
Longmans. 1012. 

Hamilton, W. H., Readings in current economic problems. Univ. 
of Chic. Press. 1914. 91-93, 93-95, 95-98. 

Hobson, J. A., Evolution of modern capitalism. Ch. 7. Lond. 
Walter Scott Pub. Co. 1912. 

Jones, E. D., Economic crises. N. Y. Macmillan. 1900. 

Juglar, C, and Thorn, C. W., A brief history of panics and their 
periodical recurrence in the United States. N. Y. Putnam. 1916. 

Marshall, L. P. and others. Materials, for the study of elementary 
economics, Pp. ,391-396. Chicago Univ. Press. 1913. 
Mitchell, W. C, Business cvcles. Berkeley. Univ. of Cal. PreSs. 
1913. 

Moore, E. L.. Economic cycles: their law and cause. N. Y. Mac- 
millan. 1914. 

Nelson, S. A., The A B C of Wall Street. N. Y. S. A. Nelson. 1900. 

Phillips, C. A. (Ed.) Readings in money and banking. N. Y. Mac- 
millan. 1916. Chs. XXVIII, XXIX. 
Sprague, 0. M. W., The crisis of 1914 in the United States. A. E.^ 
Rev., 5: 499-533. 1915. 

United States Bureau of Labor, Annual report for 1886. 




CHAPTER 11 
f INSTITUTIONS FOR SAVING AND INVESTMENT 

f § 1. The nature of saving. § 2. Economic limit of saving. § 3. 
, Commercial bank deposits of an investment nature. § 4. Investment 
I banking and bond houses. § 5. Savings banks in the United States. 
I. § 6. Security for thrift. § 7. Postal savings plan. § 8. Advantages 
•■ and limitations of postal savings. § 9. Collection of savings and educa- 
tion in thrift. § 10. Building and loan associations. § 11. The main 
features. § 12. The continuous plan. § 13. The distribution of profits. 
§ 14. Possible developments of savings institutions. 

^ § 1. The nature of saving. The motives actuating differ- 
ent classes of lenders may, for our present purpose, be re- 
duced to two: to postpone the expenditure of income, and 
to obtain a net income from wealth (or investment). Saving 
always is relative to a particular period and is for more or 
less distant ends. The child saves its pennies to go to the 
circus next week, the working girl saves her dimes for a new 
hat next spring, the earnest high-school pupil saves to go to 
; college next year, and the provident man saves for his fam- 
j?dly's future needs and for his own old age. But always, to 
J constitute saving, there must be for the time a net result : the 
,/ excess of income over consumptive outgo in that period. 
This is easily distinguishable from various forms of pseudo- 
saving of which many persons who are really spending all 
their incomes are very proud. Such forms are : planning to 
y buy a particular thing and then deciding not to do so, 
but buying something else; finding the price less than was 
expected, and thereupon using this so-called saving for an- 
other purpose; spending less than some one else for a par- 
ticular purpose, such as food, but offsetting this by larger 
outlay for another purpose, such as clothing; spending all 

158 



Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 150 

one's own income, but less than some one else with a larger 
income. We may define saving as the conversion, into expen- 
diture for enjoyable use, of less than one's net income within 
a given income period. 

Saving goes on in a natural economy both by accumulation 
of indirect agents and by elaboration so as to improve their 
quality.^ It goes on to-day by the replacement of perish- 
able by durative agents, as in replacing a wooden bridge by 
one of stone or concrete, and by producing wealth without 
consuming it, as in increasing the number of cattle on one's 
farm. But saving has come to be increasingly made in the 
form of money (or of monetary funds), and in this chapter 
we shall consider some of the ways in which this can now be 
done. 

§ 2. Economic limit of saving-. There is an economic 
limit to saving, as judged from the standpoint of each indi- 
vidual.^ The ultimate purpose of every act of saving is the 
provision of future incomes, either as total sums to be used 
later, or as new (net) incomes to be received at successive 
periods. The economic limit of saving in each case is depend- 
ent upon the person's present needs in relation to present in- 
come and conditions, as compared with the prospect of his 
future needs in relation to his future income and conditions. 
Each free economic subject must form a judgment and make 
his choice as best he can and in the light of experience. 
There is no absolute and infallible standard of judgment that 
can be applied by outsiders to each case. Yet there is oc- 
casion to deplore the improvidence that is fostered and that 
prevails, especially among those receiving their incomes in 
the form of wage or salary. Considered with reference to 
the possible maximum of welfare of the individuals them- 
selves, the apportionment of their incomes in time is fre- 

1 See Vol. I, chs. 9 and 10. 

2 See Vol. I, pp. 285-290, for the analysis of saving from the indi- 
vidual standpoint; and pp. 482-499 for its relation to general economic 
conditions. 



160 BANKING AND INSURANCE [Pt. II 

quently woful. It is uneconomic for families of small income 
to save through buying less food than is needed to keep them 
in health ; but it is (likewise uneconomic to spend the income, 
when work is plentiful and wages good, for expensive foods 
having little nutriment, and then, for lack of savings, to go 
badly underfed when work is slack and wages are small. 
There is for each class of circumstances a golden mean of 
saving. The saving habit may develop to irrational excess 
and become miserliness but this happens rarely compared 
with the many cases where men in the period of their largest 
earnings spend up to the limit on a gay life and make no pro- 
vision for any of the mischances of life — business reverses, 
loss of employment, accidents, temporary sickness, perma- 
nent invalidity, or unprovided old age. Despite the develop- 
ment of late of new agencies and opportunities for saving, 
there is need of doing more toward popular education in 
thrift.^ 

It has been estimated that the net annual investment fund 
of the United States is on the average about fifteen per cent 
of net incomes. The annual savings in the years just pre- 
ceding 1914 were probably three biUion dollars, and in 1919, 
an especially prosperous year, about ten billion dollars. Of 
course, as the amounts are expressed in terms of dollars, 
changes in the totals must be interpreted in connection with 
the changing price levels. 

§ 3. Commercial bank deposits of an investment nature. 
If a commercial bank pays no interest on demand deposits 
there is no motive for the depositor to keep a balance larger 
than he needs as current purchasing power. When his bank 
account increases beyond that point, it becomes available 
for a more or less lasting investment to yield financial in- 
come. If the sum is small, or if the owner is at all uncertain 
as to his plans, or if he is not in a position to find another 
attractive form of investment, the offer by the bank of a small 
rate of interest on special time deposits (2 or 3 per cent is 
3 See Vol. I, p. 484. 



Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 161 

not an unusual rate in sucli cases) will suffice to cause him 
to leave such funds in the bank. Since about 1900 the 
practice has been greatlv extended of paying interest even 
on "current balances" of regular checking accounts (demand 
deposits) . If the 3 per cent, rule * as to reserves against time 
deposits). If the 3 per cent rule * as to reserves against time 
a rate ranging from 2^4 to 3^4 per cent on time deposits, 
their amount will greatly increase. But still, in the future 
as in the past, those depositors having funds that can be in- 
vested for considerable periods will seek a higher rate of in- 
terest than can be obtained from commercial banks. 

In their lending function the "commercial" banks (as the 
adjective indicates) serve mainly the special needs of the 
commercial elements of the commimity — business men bor- 
rowing for short terms to carry out particular transactions. 
Loans made on short-time commercial paper (quick assets) 
are very suitable to the needs of a bank that has its liabilities 
largely in the form of demand deposits. Time deposits can 
be more safely lent on the security of real estate and for 
longer periods. Despite their limitations in this respect, the 
commercial banks must be recognized as of growing import- 
ance in the work of encouraging and collecting small savings, 
which in many cases are better invested in other ways. In 
1916, the centenary of the beginning of savings banks in this 
country, a nation-wide propaganda was undertaken by the 
American Bankers' Association for the encouragement of 
savings. 

In 1920 the national banks alone had more than 9,000,000 
deposit accounts (nearly one half of all their accounts) on 
which interest was allowed. Like information is not avail- 
able regarding state banks (and trust companies) doing a com- 
mercial business, but probably the number is as great, if 
not greater. If so, there is one interest-bearing banking ac- 
count, outside of regular savings banks, on the average, for 

4 See ch. 9, § 7. 



162 BANKING AND INSURANCE [Pt. II 

every family in tlie United States. Evidently, in many 
families there are two or more such, accounts. 

§ 4. Investment banking and bond houses. Enormous 
amounts of securities issued by governments or by corpora- 
tions (railroad or industrial) are now on the market and to 
be bought conveniently by private investors. Some bonds 
are to be had in denominations as small as $100 and $500. 
The regular brokers on the stock exchanges buy and sell, for 
a small commission, the regular bonds and investment stocks. 
For many investors the personal examination and selection 
of sound securities is too difficult a task. Several large statis- 
tical and financial agencies,^ in return for an annual sub- 
scription, offer advice to investors regarding general market 
conditions and special securities. Many banks and trust 
companies have of late developed special departments for 
investment banking. Through these agencies the banks are 
constantly placing as relatively permanent investments 
securities which they have bought or have aided ' ' to float ' ' or 
which they handle only as commission agents. In any case 
the real investment banker is bringing to his task special 
training and a high sense of his professional obligations, and 
is employing the services of statisticians, financial experts, 
and of practical engineers to determine exactly the funda- 
mental conditions of each investment. Investment banking 
promises to increase steadily in amount and importance. 

§ 5. Saving's banks in the United States. For the in- 
creasing number of wage-earners, salaried employees, and per- 
sons following professions, investment as active capitalists 
has been steadily growing more difficult.® Their savings 
must usually take the form of passive investments. The op- 
portunities for lending money in small amounts without great 
risk are few, and the requirement of skill, time, and labor to 

5 'E.g., Babson Statistical Organization, Brookmire Economic Service, 
Harvard University, Committee on Economic Research, Moody Manual 
Co., Moody Corporation Service. 

e See Vol. I, p. 318. 



Cii. 11] INSTITUTIONS TOR SAVING AND INVESTMENT 103 

look after the loans and to collect the interest is prohibitive 
to a small lender. To provide a place where small sums 
could be kept with safety and so as to yield a moderate rate 
of income, the first modern savings bank in the United States 
was instituted in New York in 1816 after a plan already 
developed in England. 

In form these banks are mutual, having no capital stock 
on which dividends are to be paid. The boards of directors 
are self-perpetuating and the members receive only fees for 
attending meetings. In their legal aspects these banks have 
a philanthropic character. Their investments are limited by 
law to specified, conservative classes of securities and loans 
on real estate. The total increase from investments is, after 
paying the expenses of operation and setting aside a surplus, 
distributable to the depositors at regular periods. In the 
United States the number of such institutions reported in 
1920 was 620, all but 24 of which are located in the North- 
eastern and Eastern states. (The 24 are all in the four 
states of Ohio, Indiana, Wisconsin, and IMinnesota). These 
banks are not increasing in number, though their -depositors 
and resources are. They have nearly 10,000,000 depositors, 
deposits to the amount of more than $5,000,000,000, an aver- 
age of $550 per depositor, or of nearly $200 per capita of the 
population of the geographical divisions in which they are 
located. Though but one third of all institutions with the 
name of "savings banks" are on the mutual plan, these are 
the most important, the typical "savings banks" in the 
United States, and hold about four fifths of all the deposits 
in "savings banks" (as distinct from the savings depart- 
ihents of commercial banks). 

Savings banks seek to keep invested as large a part as pos- 
sible of their assets, keeping in ready cash only enough to 
meet a possible temporary excess of withdrawals over de- 
posits. The mutual savings banks average about $.006 of 
actual cash (and "checks and cash items") in their tills 
for every dollar of deposits, but in addition they have for 



164 BANKING AND INSURANCE [Pt. II 

every dollar of deposits $.04 due on demand from state and 
national (commercial) banks (in the aggregate a large sum, 
much of which bears a low rate of interest). About one half 
of their resources are invested in long-time loans, mostly to 
small borrowers and on the security of real estate, and most 
of the remainder is in bonds and other securities of the 
safer kinds. The average rate of interest they have p^id to 
depositors since 1914 has been nearly 4 per -cent-; the-*ate is 
not fixed inOadvance by contract, but' is declared, at jegular 
periods (usually three months), as in the case bf' a dividend ot 
a corporation. .,-'■.'[] , ■ 

The name "savings bank" is applied also to institijtions 
known as "stock savings banks," organized for profit like 
other banks.'^ These are not in most cases sharply, marked 
off from commercial banks with savings departments. The 
number reported in 1920 was 1087, their deposits being more 
than $1,300,000,000; almost one third are in lowa'^ and al- 
most two thirds in California, the remainder (only 3 per 
cent) being in nine other states. The capital stock of these 
banks is about 9 per cent of their deposits. Since the change 
in reserve requirement for time deposits under the Federal 
Reserye Act, the contrast between savings banks and com^ 
mercial banks has become less significant and that between 
time and demand deposits (and banking departments) more 
significant. 

§ 6. Security for thrift. It is essential to sound policy 
that savings banks have the right to require depositors to 
give notice of intention to withdraw deposits. The period 
of such notice varies from a minimum of ten days (almost 
invariably now the minimum is thirty days) to a maximum 
of about sixty days. In ordinary circumstances it is not 
needful or usual for a bank to exercise this fight, but it 

TStock and mutual savings banks are botli found in only two 
states. New Jersey has 26 mutual and o^ne stock, New Hampshire' 45 
mutual and 11 stock savings banks. The'"" other stock savings banks 
are in the District of Columbia, one southern arid seven western states. 



Cii. 11] INSTITUTIONS FOR SAVING AND INVESTMENT lOo 

is a needfuil safeguard in times of commercial crises. Tliis 
requirement of notice is greatly to the advantage of de- 
positors collectively and tlius of the community as a whole. 
It is not an undue limitation of the rights of the individual 
depositor. It is unfair for the individual, in a period of 
financial stress, to seek his own safety in a manner that is 
impossible for aU, and thus to endanger the interests of all. 
The Federal Reserve Act, • by ' making it possible for loans 
to be had at any time (through member banks) on good 
security, reduced the dangel- of runs on savings banks. 

Savings banks are subject to the supervision, and inspection 
of the banking departments in the^ several' states, a fact that 
exerts a salutary effect, though not insuring absolutely 
against mistaken judgment or < dishonesty on the part of the 
bank officials. The average losses to deposits in savings 
banks have been about one-fifth of 1 per cent of total deposits. 
It is highly desirable that a plan of insurance of deposits 
should be worked out which would make savings deposits 
absolutely safe. This measure is even more important than 
that repeatedly proposed by the Comptroller of the Cur- 
rency to insure or guarantee all deposits of $5000 or less in 
national banks, the effect of which would be to bring from 
hiding-places many millions of dollars of hoarded money, 
largely prevent in the future runs on banks, and, more 
than anything else that could be done, unify and solidify 
the entire banking system. It would doubtless also greatly 
stimulate the saving habit among the people and increase 
the use made of the savings banks. 

The depositors in savings l)anks have a direct legal claim 
on the bank as a corporation. The bank's only means of 
payment are its assets, consisting of claims iipon the owners 
of such wealth as houses, factories, railroads, electric-light 
plants, good roads, and school "buildings. Thus virtually 
the depositors have by their savings made possible the build- 
ing and equipping of these actual forms of wealth, and have 
an equitable claim upon the usance of them, which claim 



1G6 BANKING AND INSURANCE [Pt. II 

is met by the payment of interest and dividends by the sav- 
ings banks. Viewed in this way, the great social importance 
of the savings function appears, and the importance of de- 
veloping the savings institutions. 

§ 7. Postal savings plan. In many countries of the world 
the governments have not only authorized private, corporate, 
and trustee savings banks, but have provided public agencies 
where it is possible for the citizens to deposit small amounts. 
Thus municipal, and what are called communal, savings 
banks are operated by many European cities; but the most 
effective and widely used agencies for the purpose are the 
national post-offices. Postal savings banks, or postal savings 
systems as divisions of the postail service, are now found in 
all the larger countries of the world, and in many smaller 
ones. The United States of America was almost the last 
civilized country to establish such a system, which was author- 
ized by act of Congress in 1910, and went into operation in 
a few designated cities in January, 1911. The number of 
offices at which it was in operation was rapidly increased, 
and deposits began to flow in at the average rate of more 
than a million dollars a month, and then more rapidly until 
the war period. The maximum balance to the credit of de- 
positors was attained in March, 1919, when it was $177,000, 
000, from which point the withdrawals have pretty reg- 
ularly exceeded the new deposits each month. This may 
be explained by the rise of the general interest rate, the 
opportunities for good investments of small sums in Liberty 
Bonds, and heavy withdrawals by immigrants for remittance 
to Europe. 

The funds of the postal savings system are deposited in 
banks belonging to the Federal Reserve system, which must 
deposit with the Treasurer of the United States designated 
kinds of bonds (national, state, and municipal) as security, 
and pay interest at the rate of 2i/^ per cent on the amount 
of the deposits. The % per cent difference between this 



Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 1C7 

rate and that paid to individuals goes far toward paying 
the expense of operating the system. 

Provision is made for the issue, in exchange for certificates 
of postal savings, of bonds bearing interest at the rate 
of 21/2 per cent. Postal savings bonds are exempt from 
all kinds of taxes, federal and local. 

§ 8. Advantages and limitations of postal savings. As 
compared with ordinary savings banks the postal savings 
system has certain advantages. 

(a) It protects the small depositors from the danger of 
dishonest private bankers who have preyed upon immigrant3 
in the larger cities. To foreigners, accustomed to the postal 
savings plan in their home countries, it is especially useful. 

(b) It gives to every depositor the greatest safety possible, 
as "the faith of the United States is solemnly pledged" for 
the repayment of depositors. 

(c) It brings a savings institution to many a small town 
and rural place formerly entirely lacking in facilities for 
small depositors. The benefit of this has not immediately 
appeared to be great, but may in time prove to be, 

(d) It pays interest from the first of the month following 
the date of deposit, whereas the usual practice of savings and 
commercial banks is to pay only from the beginning of the 
quarter year or half year. 

(e) It provides for the exchange of deposits for bonds 
hearing a higher rate of interest — a unique feature greatly 
simplifying for the smaill saver the process of buying bonds 
for more lasting investment. 

In some respects, however, the postal savings system offers 
less favorable conditions than do ordinary banks, and its 
iisefulness was deliberately restricted by provisions in the 
law, as has been clearly pointed out and deplored by com- 
petent critics. The post-office will not receive deposits of 
less than one dollar, whereas regular savings banks usually 
accept for deposit as small an amount as ten cents. It pays 



168 BANKING AND INSURANCE [Pt. II 

only 2 per cent interest (only half as much as the regular 
savings banks now pay) and only for a full year instead of 
quarterly. Only simple interest is paid, not interest com- 
pounded automatically, as in the case of banks. These and 
other features of the law so greatly restrict the usefulness 
and appeal of the system that its failure to grow is not 
surprising. With wise and proper changes it should be pos- 
sible to refund a large part of the national debt in securities 
issued in small denominations through the postal savings 
system. 

§ 9. Collection of saving's and education in thrift. Small 
savings have been encouraged in many places by penny provi- 
dent funds, dime savings banks, and school savings funds, 
which have been conducted at public schools, social settle- 
ments, and factories, by school officers and by charitable and 
educational societies acting through canvassers. These plans 
all call for much personal effort and cost, which must be pro- 
vided by volunteer services and private gifts. These plans 
being undertaken mainly as a means of education in thrift 
and in the related moralities, their results are not to be meas- 
ured merely by the magnitude of the sums collected. They 
are not rivals of the ordinary savings banks, but rather 
auxiliary methods of encouraging their use. The funds col- 
lected by these agencies are usually deposited in local savings 
banks, and depositors are encouraged to open individual ac- 
counts there, whenever they have considerable sums saved. 

Before the Great War began, public schools in Germany 
were equipped with automatic machines vending savings 
stamps in as small denominations as ten pfennigs (2i/^ cents) 
when a coin was dropped into a slot. This method could be 
used effectively in connection either with the postal sav- 
ings system or with a local savings bank. It ought to be 
made easy to deposit funds at every schoolhouse, at every post- 
office, at every factory counter on pay-day, and wherever 
people pass in numbers. Allurements to foolish expenditures 
meet old and young at every turn ; to spend the nickel or the 



Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT IGO 

dime is made all too eas}', whereas to save it and deposit it 
in a safe place too often calls for wasteful and discouraging 
efforts from the person of small means. 

§ 10, Building and loan associations. Building and loan 
association is the name applied to a cooperative organization 
having as its purpose the collecting regularly' from mem- 
bers of small sums which are loaned to some members for the 
purpose of building or paying for homes.^ The first associa- 
tion of this type was organized in Frankford, Pennsylvania, 
in 1831. It and others of its kind have made Philadelphia 
notable among all the larger cities as "the city of homes." 
The number of such associations has almost steadily increased 
in the United States. Pennsylvania continues to rank first in 
respect to amount of total assets, with Ohio a close second, 
and New Jersey third (though ranking first in proportion 
to population). Associations of this type have been hardly 
second in importance in America to the savings banks as 
institutions for savings for persons of moderate means. The 
number of their members (in 1920) was 4,300,000, which is 
about one third of that of savings banks depositor's, and the 
amount of their assets ($2,100,000,000) is nearly one third 
that of the reported savings banks. But they are growing 
more rapidly, and their relative influence in educating and en- 
couraging to thrift is doubtless much greater than these figures 
indicate. There are nearh^ eight thousand of them, more 
than three times as many as savings banks; their manage- 
ment is much more democratic than is that of the banks; 
and many of their members attend and participate in the 
meetings and understand how they are conducted. Moreover, 
the savings made through these associations are constantly 
passing on into houses that are fully paid for, and that 
continue to yield their usances and rents to their owners. 
Each year these associations collect from their members as 
dues and in repayment of loans (made to build houses) the 
sum of more than half a billion dollars, which is twice as 

8 See Vol. I, pp. 290, 297-298, 484, and 486. 



170 BANKING AND INSURANCE [Pt. II 

much as the annual increase in the deposits of the reported 
savings banks. 

These associations are properly made subject to supervision 
and examination by state officials, in the manner of that 
exercised over banks. They have been favored by exempting 
the shares of members and the mortgages held by the associa- 
tions from all state and municipal taxation. As the houses 
built or paid for are taxed, this is of course just, but it is 
an exception to the rule of the illogical general property tax.^ 

The figures here given and the description of methods 
apply to the "local" building and loan associations. The 
success of this kind led to the organization of other associa- 
tions which took the name ''National" building and loan as- 
sociations, to carry on a business in a larger field. The num- 
ber of these has always been comparatively small, and their 
operation is less simple, democratic, and economical than the 
local associations. They have had more of the nature of or- 
dinary profit-making enterprises. They should not be con- 
fused with the local associations. 

§ 11. The main features. A building and loan association 
is organized by a group of persons in a neighborhood, unit- 
ing to form a corporation under the laws of the state, every 
member to subscribe for one or more shares. The officers 
elected all serve without pay, excepting the secretary-treas- 
urer, who receives a small fee for his services. All official 
meetings are open to all members. The shares vary in de- 
nomination from $25 to $200 ; the larger figure being common 
under the serial plan and $100 being usual under the con- 
tinuous (or permanent) plan, described below. Whenever 
there is a sufficient sum it is lent toi one of the members for 
the purpose of building a house. The borrower must sub- 
scribe for shares to the par value of his loan. Usually the 
loans made are large enough to cover a large proportion 
of the cost of the house, but the land on which the house 
stands must be free from all encumbrance, and its value 

9 See eh. 18, § 4. 



Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 171 

gives a margin of safety to the association. Then by the 
method of payment of dues the debt is, from the first month, 
steadily reduced and the security for the loan therefore 
grows constantly better. 

The receipts of the association are of several kinds. 

(a) Interest is received from borrowing members, usually 
at the rate of 6 per cent, and from banks at a lower rate on 
the small working cash balances kept on deposit. 

(b) Premiums may be charged, either in the form of a 
higher rate of interest bid by the applicant for a loan, or 
in the form of additional weekly dues. Dozens of premium 
plans are in effect or have been tried, but the practice of 
charging premiums has decreased so that the total premiums 
now constitute less than 1 per cent of all payments from 
members. 

(c) Fines for delinquency also are less commonly imposed 
now and constitute a small fraction of 1 per cent of total 
payments. 

(d) Deductions are made on account of withdrawal before 
the maturity of these shares; under these circumstances it is 
usual to pay a portion but not all of the accumulated profits, 
sometimes a proportion increasing as the shares approach 
maturity. 

Different plans have been and still are followed in respect 
to the method of issuing the shares. Under the terminating 
plan all the shares begin and mature at the same time (for 
all members that continue to the end), whereupon the associa- 
tion dissolves or starts anew. The chief difficulty in this plan 
is that the association has too few funds to lend at the begin- 
ning of its career, and a surplus of unlendable funds as it 
nears the maturity of the series. It is therefore necessary 
to encourage or to compel the withdrawal of non-borrowing 
members on the payment of estimated profits to date. 

The better to remedy this difficulty, the serial plan was de- 
vised, by which new series of stock are issued at intervals — 
yearly, half-yearly, quarterly, and even oftener. 



172 BANKING AND INSURANCE [Pt. II 

§ 12. The continuous plan. A further development is 
the contimious plan (usually called the permanent or the 
Dayton plan), by which much greater flexibility is attained 
in the organization. Shares of stock may be subscribed for 
at any time, each man's separate subscription of shares being 
treated as a separate series, and maturing each at its own 
time. There is thus, after an association has been for some 
time in operation, a continuous stream of new members (or 
new subscriptions) flowing into the association, and a con- 
tinuous outflow of shareholders whose shares have matured. 
The maturing shares of borrowing members discharge their 
indebtedness to the association; the maturing shares of non- 
borrowing members are paid in money, or may (if the as- 
sociation has use for the funds) be left as an interest-bearing 
loan. 

Additional funds are obtained when needed by issuing 
paid-up stock to non-borrowers. This is convenient at the 
beginning of an association and when the movement in build- 
ing is more active than usual. But if an association has 
funds that cannot be loaned, outstanding paid-up stock may 
be called in. In practice a large part of the paid-up stock 
as well as of the running stock is subscribed for and held, 
not by large capitalists, but by persons of small means, 
especially ''the more frugal element in the working classes." 
Non-borrowing members desiring to withdraw may do so at 
any time under certain conditions ; but the laws usually require 
that thirty days' notice of intention to withdraw shall be 
given, that not more than one half of the funds received 
in any one month shall be paid on withdrawals, and that 
withdrawing shareholders shall be paid in the order of the 
notices of intention to withdraw. These safeguards make 
impossible anything like a "run" on a bank or a forced 
liquidation of the association. 

The most intelligent and prudent workers were formerly 
deterred from subscribing by the fear that sickness, unemploy- 
ment, or other mishap might make it impossible to keep up 



Cii. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 173 

reg'ular payments. Now, however, fines for late pa^-ment 
have been almost entirely done away with. On the other 
hand, extra payments may be made at any time by borrow- 
ing members, to hasten the date when their shares mature 
and their debt will be discharged. These privileges are pos- 
sible because of the method of distributing profits, which 
will now be described. 

§ 13. The distribution of profits. At least twenty-five 
plans, with hundreds of variations in details, have been in 
operation for the distribution of profits. The essential fea- 
tures are, however, these. Periodically, usually every six 
months, is ascertained the amount of the gross earnings, 
which, under this plan, consist almost entirely of interest 
paid on loans. From this amount are deducted expenses 
(and in some states 5 per cent of the total is placed in a 
"loss fund" to meet possible losses), and the rest is divided 
in proportion to the amount standing to the credit of each 
member, being credited to the account of running stock, in- 
creasing its "book value," and paid in cash to holders of 
paid-up stock. The dues frequently are 25 cents a week 
per share, in other cases $1 per month. Take, for example, 
the latter case, when the maturing value of a share is $200. 
If all of the capital paid in is lent out continuously at 6 
per cent, the profits will be equal to about 6 per cent com- 
pound interest, and the shares will mature in about 11^^ 
years (the average experience has been 138 months). A non- 
borrower will then be paid $200, of which $138 has been 
paid as dues over the period and $62 is the accumulated 
profit of each share. A borrower of $3000 (on this plan) 
must take at least fifteen shares, and would pay $30 each 
month, $15 as dues and $15 as interest. If he keeps up 
his regular payments, he will at the maturity of his shares 
have a capital just sufficient to pay off the whole debt. In 
most cases a prudent tenant can become the owner of a house 
while paying no more than the rent would be. As the 
active investor he becomes his own rent-collector, and uses 



174 BANKING AND INSURANCE [Pt. II 

the house with less need of repairs, thus dispensing with 
services and costs that are included in contractual rents.^° 

§,14. Possible developments of savings institutions. 
The social importance of increasing and improving the 
agencies of savings for the masses is being more fully recog- 
nized, but much more might be done in these directions. 
Some possible changes have been suggested above, and a few 
words more may be added. 

Probably the greatest developments in the near future will 
be through the savings departments of commercial banks 
(favored by the reserve rules of the Federal Reserve Act) 
rather than by the increase in the number of special banks 
for savings. The initial expense and risk of starting a sav- 
ings bank is considerable, and outside of cities of some size 
this is prohibitive; whereas a savings department, with its 
funds and reserves separated, can be easily and cheaply oper- 
ated in connection with a general bank. It is much to be de- 
sired, however, that a larger measure of popular cooperation 
might be made possible to the depositors, both for its educa- 
tional value and to reduce the real evil of the autocratic or the 
plutocratic centralization of the money power in the small 
communities. Savings banks usually limit the amount of an 
account to $3000. It is desirable that depositors should be 
able easily to convert their savings-bank deposits over cer- 
tain amounts into good bonds, bearing a higher rate of in- 
terest (after the method of the issue of postal savings bonds). 
There is need of a central market in each community where 
bonds can be bought and sold at any time ; and banks ought, 
as they increasingly do, to buy and sell for their customers 
in this way in the larger bond market. This would be of 
benefit also to the states and municipalities that issue bonds 
for such purposes as schools, roads, and public utilities, 
by creating a more open and regular market to small in- 
vestors tSan now is provided for such securities. This might 
somewhat reduce the rate of interest, and there would be 

10 On these economies, see Vol. I, p. 298. 



Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 175 

a gain divided between taxpayers and lenders. The large 
amoimts of Liberty bonds now are especially suitable for 
the small investor. 

The general plan and principles of local building and 
loan associations was extended in 1916 to groups of rural co- 
operators in the joint-stock land banks, enabling them to 
make loans to their members" ; and it might well be extended 
to groups of small investors, permitting them to hold real- 
estate mortgages and bonds and stocks of corporations, free 
from taxation other than that paid on the wealth itself. 
Members of such organizations could get a higher income on 
their investments than a savings bank could pay, and with 
greater security than if each attempted to save and invest by 
himself. 

'Savings institutions are necessarily also lending institu- 
tions. In this chapter they have been looked at mainly from 
the saver's (the lender's) standpoint, though their service 
to the borrower is of coordinate importance. In the case 
of building and loan associations this feature is most apparent. 
Later, the problem of the agricultural bori'ower will receive 
further consideration. 

11 See ch. 27, below. 
References. 

Chamberlain, Laurence, Principles of bond investment. 4th ed., 
N. Y. Holt. 1911. 
The work of the bond house. 1913. 

Devine. E. C, Peoples cooperative bank for workers in towns, and 
small holders, allotment cultivators, and others in coimtry dis- 
tricts. N. Y. Cassell. 1908. 

Dexter, f^eymour, A treatise on cooperative savings and loan associa- 
tions. N. Y. Appleton. 1894. 

Hamdlton, J. H., Savings and savings institutions. N. Y. Mac- 
millan. 1902. 

Kemmerer, E. W., Postal savings. P. 176. Princeton. Princeton 
University Press. 1917. (A historical and critical study of the 
postal savings system of the U. S.) 

Kniffin, W. B., The savings bank and its practical work. N. Y. 
Bankers Pub. 1912. 

Phillips, C. A.. Readings in monev and Ijanking. N. Y. Macmillan. 
1916. Ch. XVI. 

Wolf, n. W., A cooperative bank handbook. Lond. King. 1909. 
Cooperative banking. Lond. King. 1907. 
People's banks. 3d ed. N. Y. . Longmans. 1910. 



CHAPTER 12 
PRINCIPLES OF INSURANCE 



§ 1. Chance, unavoidable and average. § 2. Uneconomic character of 
gambl|ing. § 3. Borderland of gambling. § 4. Insurance: definition 
and kinds. § 5. Insurance viewed as a wager. § 6. Insurance as 
mutual protection. § 7. Conditions of sound insurance. § 8. Farmers' 
mutual insurance. § 9. Joint-stock insurance of property. § 10. 
Purpose of life insurance. § 11. Assessment life insurance. 

§ 1. Chance, unavoidable and average. Every action and 
every movement in life has in it some element of chance. 
There are what may be called natural chances, arising from 
the uncertainties of the seasons, or from rainfall, heat, hail, 
storm, flood, lightning, or land-slides. Such chances must be 
taken both by the small enterpriser and by the large. In 
earlier conditions of society natural chance dominated in- 
dustry, and it still remains and must always remain impor- 
tant. There is the chance of unexpected political events, 
such as war, riot, and legislation on money, tariffs, credit, and 
business relations. These things are caused, it is true, by the 
action of men, but it is a collective action out of the control 
of the individual. There is the chance of human careless- 
ness causing fire, explosions, and wrecks on misplaced switches. 
There is the chance of physical or mental collapse, as the 
sudden insanity or the sudden death of one performing 
responsible duties. There is the chance of sickness that often 
wrecks the plans and the fortunes of a whole family. There 
is the chance of economic alterations in methods of production 
and of transportation, in fashions and demand in this direc- 
tion or for those materials. 

Some of these chances are more connected with money- 

176 



Ch. 12] PRINCIPLES OF INSURANCE 177 

lending, others with manufacturing, some with agriculture, 
others with commerce; but all are present in some degree in 
every industry. iSome events are unique in nature and seem 
unlikely ever to occur again ; others are of a kind occurring 
so irregularly that no reasonable prediction can be made as 
to the time and frequency of their occurrences. Still others 
occur frequently and to many different persons ; but no indi- 
vidual can tell when and how they will occur to liim. A 
general average of chances in different lines of business causes 
some to be called safe, others extra-hazardous. Chance may 
be favorable as well as unfavorable. Extra-hazardous enter- 
prises must in general afford a higher average of profit in 
order to induce men to engage in them. It is folly to take 
a risk without ascertaining its degree as far as general ex- 
perience enables one to choose. But inasmuch and in so far 
as the gains and losses fall unequally upon different indi- 
viduals, income depends upon chance. 

§ 2. Uneconomic character of gambling". This prevalence 
of chance sometimes tempts men to say that business is a 
' ' gamble. ' ' But a distinction in principle must be made be- 
tween gambling and legitimate risk-taking. The chances 
enumerated above are not sought, but avoided as far as pos- 
sible ; yet they must be borne by some one if productive enter- 
prise is to continue, and the burden must somehow be dis- 
tributed throughout the community. Gambling is, however, 
a kind of risk-taking that has a very different economic and 
moral quality. Gambling creates the hazard, making the 
gain or loss of income depend on an event that is not a neces- 
sary part of productive enterprise. Typical gambling is the 
transfer of wealth on the outcome of events absolutelj'- un- 
predictable, as far as the two gamblers are concerned. Ex- 
amples are the shaking of unloaded dice or the honest deal- 
ing of a pack of cards, and the betting on prices in so-called 
"bucket-shops" by persons having no connection with the 
market of real things, and seeking to get something for noth- 
ing as a result of mere chance. 



178 BANKING AND INSURANCE [Pt. II 

Cheating is not a necessai?y mark of gambling, although 
the cruder forms of dishonesty, such as the loading of dice or 
the collusion of horse-owners or of horse- jockeys to deceive 
the betting public, are so common that they seem often to be 
an essential feature. Gamblers recognize fair as opposed to 
unfair methods. Fair gambling is a kind of minor morality 
within the immoral field of gambling, like the honor found 
among thieves. The chance-taking in gambling, has no use- 
ful purpose or result outside itself. Betting and gambling 
do not produce wealth, but merely shift the ownership of ex- 
isting wealth. The gamblers constitute themselves a little fic- 
titious economic circle, and they transfer gains and losses on 
the turn of events that have no practical objective result 
within their circle except to determine the direction of the 
transfer. 

Even when fairest, gambling must, in its average results, 
be uneconomic. In any economic trade each trader gains 
by getting goods that are, on the marginal principle, to him 
more valuable than the other kinds of goods he gives up.^ 
But in gambling the winner gets all, the loser gets nothing. 
If two men of like incomes gamble, the additional desires that 
the winner is able to gratify are (by the principle of decreas- 
ing gratification) less in amount than the desires that the 
loser must forgo. As a result the loser is often seriously in- 
jured by the loss of his income, and driven to despair, while 
the winner makes reckless and extravagant use of his win- 
nings. Easy come, easy go, is the rule of gamblers. More- 
over, gambling reduces the amount of wealth by relaxing 
the motives of economic activity, diverting energy from pro- 
ductive enterprise, tempting men into dishonesty to offset 
their losses, and leading them into speculation and embezzle- 
ment. 

§ 3. Borderland of gambling. Ranging between the ex- 
tremes of unavoidable risk-taking and of gambling are a num- 
ber of cases of a mixed nature. In nearly all wagers, judg- 

1 See Vol. I, ch. 5, § 7. 



Ch. 12] PRINCIPLES OF INSURANCE 179 

ment in some degree influences the choice of sides. One man 
bets on a horse whose pedigree and performances he knows 
thoroughly; another judges by the horse's appearance as it 
comes upon the track. The professional bookmakers have 
the latest possible and most exact information on which to 
base their bids. 

In the bets made on one's own prowess, as on speed in run- 
ning, the chance-taking is still on the uneconomic side of the 
borderland, certainly if the running is for the sake of the 
wager, not for pleasure or for a useful purpose. A premium 
won by a runner for speed in delivering a message of econ- 
omic importance presents an essential contrast to the winnings 
in a wager. 

Finally, the very borderland of difficulty is reached in the 
purchase and sale of goods in the market with a view of profit- 
ing by chance changes in price. The purchasing and holding 
of land, lumber, grain, cattle, and other tangible and useful 
things, that need to be stored, held for buyers, or taken to 
market, must be judged liberally. The quality of gambling 
depends somewhat on the motive as well as on the ability of 
the trader. The enterpriser dealing with real wealth, and 
fitted to take the risks both because of his resources and of 
his exceptional knowledge, needs the motive of gain in such 
cases, and in a sense can be said to earn socially what he 
gets. The motive of the uninformed must be a blind trust 
in luck, and a hope to gain from a rise in prices which they 
are quite unable to foresee or to explain, 

§ 4. Insurance : definition and kinds. The large element 
of luck in industry due to unavoidable chances has something 
of the same evil character as gambling. It brings unearned 
prizes to some and to others unmerited losses. It must there- 
fore be a benefit to the community, if this element of unavoid- 
able chance cannot be reduced as a whole, at least to regu- 
larize it and make it exactly- calculable for any individual. 
In this way each may be encouraged by the more certain pros- 
pect of receiving a reward proportionate to his efforts and 



180 BANKING AND INSURANCE [Pt. II 

abilities. This desirable condition has in many respects been 
accomplished by means of insurance. 

Insurance is a guaranty of partial or complete indemnity 
against a financial loss that will result if an event of a speci- 
fied kind occurs. The person seeking some surety against the 
possible loss is the insured; the person contracting to in- 
demnify against the loss is the insurer; the written contract 
of insurance is the policy; the price paid by the insured 
in fulfilment of his part of the contract is the premium; 
the amount paid when a loss has been incurred is the in- 
demnity; and the person to whom the indemnity is paid is 
the beneficiary (who may or may not be the insured). 

The insurance with which we are here concerned is that 
which gives financial indemnity. This is given for loss of 
expected net income, when by chance either receipts are less 
or costs are more than average. The two main classes as 
regards kinds of loss are property insurance and personal 
insurance. Property insurance is that which indemnifies for 
loss of one's possession in specified ways, such as by fire, by 
the elements at sea (marine), by hail, lightning, or cyclone, 
by death (of valuable animals), by robbery, and by break- 
age (as of window-glass). Personal insurance is that which 
indemnifies the beneficiary for loss of income as the result of 
various happenings to persons, the chief being death, acci- 
dent, sickness, invalidity, old age, and unemployment. The 
principle of insurance is being constantly extended to new 
subjects. The Jeffries-Johnson and the Dempsey-Carpentier 
prize-fights were insured against rain. Frequently race- 
horses, the fingers of pianists, the lives of ball-players, and 
the throats of singers are now insured. Summer hotels in 
England regularly insure for large sums against more than 
so many days of rain per season. Insurance is capable of 
further development in a variety of directions. 

§ 5. Insurance viewed as a wag'er. Insurance, without 
question a highly useful thing, appears, paradoxically, to be 
in its outer form a bet. The large merchant with many ves- 



Cm. 12] IMJIXCIPLES OF INSURANCE 181 

sels used in many kinds of business had in the days before 
marine insurance an advantage in distributing- his losses over 
a number of voyages. Antonio, the wealthy merchant, is 
made thus to express his security : 

"My ventures are not in one bottom trusted 
Nor to one place; nor is my whole estate 
Upon the fortune of the present year. 
Therefore my merchandise makes me not sad." 

In its early form marine insurance was the attempt of 
smaller ship-owners to distribute their losses (as could the 
wealthy merchant) over a number of undertakings, lucky and 
unlucky. It became customarj^ for a ship-owner to bet with 
a wealthy man that the ship would not return. If it did 
come back, the owner could afford to paj- the bet; if it did 
not, he won his bet and thus recovered a part of his loss. 
Gradually there came about a specialization of risk-taking 
by the men most able to bear it. They could tell by ex- 
perience about what was the degree of uncertainty, and could 
lay their wagers accordingly. When several insurers were in 
the same business, competition forced them to insu-re the ves- 
sel and cargo of the ordinary trader for something near the 
percentage of risk involved. The insurance thus tended to 
become a mutual protection to the ship-owners; what had to 
be paid in premiums to cover risk came to be counted as part 
of the cost of carrying on that business. 

Every legitimate form of insurance exhibits the character- 
istics that it reduces loss at the margin where it is felt most 
keenly. The difference between insurance and gambling, 
thus, lies primarily in the purpose of insurance, which is 
not to increase artificially the risk that the insured runs, 
but to neutralize or offset an already existing chance. The 
insurance bet is what is called a "hedge." 

§ 6. Insurance as mutual protection. The difference be- 
tween gambling and insurance lies further in the collective 
method of insurance, which combines the chances scattered 
among a number of persons. Insurance does not increase the 



182 BANKING AND INSURANCE [Pt. II 

total of risks and of losses, but merely combines, averages, 
and distributes them equally among all the insured. This 
eliminates the chance element to the individual by converting 
it into a regular cost to all members of the group. Modern 
insurance is conducted either by enterprisers for profit, or 
by mutual companies; but in any case in large measure the 
losses in insurance are mutually shared, as the premiums 
(plus interest earned) equal the total losses plus operating 
expenses and profit, if any is made. Each insured gets a 
contract of indemnity for the payment of a sum that will help 
cover the losses of others. Such an exchange is mutually 
beneficial. The premium comes from marginal income; the 
loss, if it occurs, would fall upon the parts of income having 
higher value to the insured. The less urgent needs of the 
present are sacrificed in order to protect the income that 
gratifies the more urgent needs of the future. In insurance 
each party gives a smaller value for a greater; each makes 
a gain. The greater security in business stimulates effort. 
This effect is quite the opposite of that of gambling. 

§ 7. Conditions of sound insurance. To be economically 
sound, insurance must have to do with real productive agents, 
and with a group of occurrences that, as a whole, are ap- 
proximately ascertainable in advance — however irregularly 
they may fall upon individuals. The insured must be numer- 
ous enough, and the objects insured so distributed in space 
and in time, that the "law of large numbers," or of statis- 
tical averages, applies. This means that in any one year the 
cost will not vary greatly from the average ; otherwise the 
security is weakened. 

The beneficiary must have an insurable interest in the 
property or person insured, that is, the beneficiary must 
actually suffer a loss by the occurrence insured against, and 
the amount of the indemnity must not be greater than the loss 
incurred. 'Some of the greatest difficulties in insurance arise 
from the absence of these essential conditions. "When there 
is no insurable interest, or when the indemnity is greater 



Ch. 12] PRINCIPLES OF INSURANCE 183 

than the loss that may be incurred, the beneficiary may and 
sometimes does find it to his interest to bring about the 
socially injurious event insured against. He artificially in- 
creases the loss against which insurance was taken. When 
the insured sets fire to his own buildings, or drives his auto- 
mobile more carelessly than he otherwise would, he makes 
an illegitimate use of insurance. Constant efforts are made 
by insurance companies to guard against these ' ' moral risks, ' ' 
the least calculable of any. Merchants whose stocks have 
been mysterioush^ burned two or three times find difficulty 
in getting further insurance. Formerly insurance was not 
paid in case of death by suicide; but now usually no such 
limitation is contained in a policy after a period of one or 
more years. As men rarely plan suicide years in advance, 
death by one's own hand some years after taking life insur- 
ance is regarded as coming under the ordinary rules of 
chance. Yet it is to be feared that this liberal policy ser\es 
as a temptation at times to crime and to self-destruction. 

§ 8. Farmers' mutual insurance. Property insurance 
may be viewed as an aspect of enterpriser's cost,^ but may 
also, as may any insurance, be considered a form of saving. 
The premium paid each year may be looked upon as a sum 
prudently saved and laid aside to repair or rebuild the house 
when later it burns. Let us suppose that the chance of any 
one house being destroyed by fire in any one year is 1 in 
500 ; then, on the average, the owner of each house would 
in 499 of the years have no loss from fire and the other 
year would lose the whole house. If the loss could be 
mathematically distributed over 500 houses, each house would 
burn down 1/500 each year, never more nor less, and fire 
loss would be a regular cost of repair. If no provision is 
made for this, the actual income of each owner in his lucky 
years would be .2 per cent greater (estimated on the cap- 
italization) than, on the average, is the net income of the 
whole group of owners. A prudent owner of one house, 

2 See Vol. I, pp. 365 and 374. 



184 BANKING AND -INSURANCE [Pt. II 

understanding this, could only in small measure protect him- 
self against this loss by setting aside each year $2 for each 
$1000 of valuation, for any year his whole house might burn 
down, long before he had laid aside its valuation. If, how- 
ever, one man owned 500 houses of equal value, so situated 
that no two of them could ever catch fire from the same 
cause, and if in fact fate so distributed the fires that just 
one house burned down each year, his loss would be actually 
distributed in time according to the mathematical proba- 
bility. If 500 different owners of houses, alike but each 
located apart from all the others, band together, they, be- 
come collectively like one owner of 500 houses as regards the 
chance of loss in any one year. Still better, if 10,000 owners 
unite, the distribution of losses will approach much more 
closely to the mathematical probability. 

In fact, a very simple application of this idea has been 
made in the insurance of farm property. It was a not un- 
common custom in agricultural communities in America for 
the neighbors to band together to help rebuild a house that 
had been destroyed by fire, or to take up a collection for the 
family that was in distress. Insurance affords a more regular, 
equitable, and effective way of accomplishing the same pur- 
pose, and likewise is a cooperative enterprise of neighbor- 
hood good- will. There are now about two thousand farmers' 
mutual fire insurance companies in the United States,"* with 
$6,000,000,000 of insurance in force, insuring the property 
usually up to a maximum of two thirds of the estimated true 
value. Usually the organization of these companies is simple, 
their officers unpaid, the overhead expenses very small, and 
the operations of each company limited to a small area, a 
township or at most a county. 

Premiums are usually not collected, or even determined, 

3 These figures were collected by V. N. Valgren, investigator in 
agricultural insurance for the United States Department of Agriculture. 
They do not include a large number of similar companies that carry 
risks other than farm property to an extent greater than 35 per cent. 



Cir. 12] PRINCIPLES OF INSURANCE 185 

ill advance; but, the losses having been determined at the 
end of the year, the amount is collected pro rata in propor- 
tion to the face of the policies in force. More often of late, 
to add to safety and to equalize variations in losses from 
year to year, a small reserve is laid aside, $3 per thousand 
dollars of insurance in force being deemed ample for this 
purpose. Otherwise this is pure assessment fire insurance, 
and is not only very inexpensive, but very generally safe and 
convenient. This cooperative plan is, however, less suit- 
able in an urban neighborhood, because of the concentration 
of risks. 

Mutual hail insurance companies provide on a similar plan 
indemnity for the destruction of growing crops. Forty-one 
such mutual companies were in existence in 1919, and in 
recent years have collected premiums ranging from $3,000,000 
to more than $6,000,000 a year. The smaller measure of 
success of these, as compared with the mutual fire insurance 
companies, is largely due to the irregularity^ of the losses 
from year to year and their wide extent when they do occur. 
The risks are not distributed in a manner suitable, for neigh- 
borhood insurance, and mutual companies that are not or- 
ganized and managed in a neighborhood are less honestly and 
efficiently run. In the attempt to improve conditions, four 
states (the two Dakotas, Nebraska, and Montana) had hail 
insurance departments and collected premiums (in the j'ear 
1919) of more than $6,000,000, paying losses of three fourths 
of that amount, and setting aside a surplus. Mutual and 
state hail insurance premiums are virtually collected on the 
assessment plan, but it has been found best to collect a 
definite amount in advance, and, in case of unusual losses, 
to pro-rate among the losses the premiums collected. The 
plan of mutual property insurance is likewise being applied 
to live stock and other farm property. 

§ 9. Joint-stock insurance of property. i\Iuch the largest 
part of insurance against fire and other causes of property 
losses is carried by joint-stock companies, or by so-called 



186 BANKING AND INSURANCE [Pt. II 

mutual companies. Though these companies have, like banks, 
more of a public character than have most businesses, 
and are subject to special legislation and supervision by 
state officials, they were organized and are conducted pri- 
marily for the profit of the owners. Even in many rural 
districts, especially where conditions are unfavorable to 
mutual companies, the joint-stock companies have large 
amounts of insurance in force, and in urban communities 
they all but completely obtain the business. The joint-stock 
fire insurance companies * collect each year in the United 
States $700,000,000 in premiums on risks to the value of more 
than $72,000,000,000, The premium rate thus averages about 
1 per cent. In 1917, a fairly representative year, substan- 
tially this group of companies returned to the insured, in pay- 
ment of losses, only 48 per cent of the premiums received, 
used 34 per cent for expenses, and applied the remaining 
18 per cent either to dividends or to surplus. The dividends 
were nearly 15 per cent of the capital stock (a considerable 
portion of which represented stock dividends in previous 
years) and the increase in assets 84 per cent of the capital 
of the preceding year. When it is considered that 20 per cent 
of all premiums received are paid in commissions, and that 
in the case of the higher officials the salaries and commissions 
run to very large amounts, it appears that the insurance 
business is exceedingly profitable to the fortunate few in 
control of these organizations. The starting of new com- 
panies is now attended with increasing risk and cost, so that 
^the existing companies occupy, in some respects, a monopo- 
listic position. Another large group of stock companies 
(about 200) engaged in casualty, surety, and miscellaneous 
insurance, very rapidly growing in magnitude and impor- 
tance, now collecting more than one third of a billion dollars a 
year in premiums, returned (in 1919) to the policy-holders 

4 National Board tables for 1917, published in the "Insurance Year 
Rook," 1918, p. 448. The Spectator Company. Mostly fire insurance, 
but including marine, automobile, and other business, see also, p. 540. 



Ch. 12] PRINCIPLES OF INSURANCE 187 

41 per cent ("including all expenses in connection with pay- 
ment of claims") and expended 40 per cent on actual ex- 
penses of management. 

§ 10. Purpose of life insurance. Of all forms of insur- 
ance at present, the most important in the extent of its finan- 
cial operation and as an agency of thrift is life insurance. 
The total receipts (about $1,800,000,000 in 1919) of life in- 
surance organizations (fraternal, ordinary, and industrial) 
are almost twice those of all other forms of insurance, and 
the total assets more than twice as great ($6,800,000,000 in 
a total of $9,100,000,000 in 1919). 

Life insurance is to provide partial indemnity for sur- 
vivors against the financial loss incurred by the death of the 
insured. UsuaUy the insured is the bread-winner of the 
family and the beneficiarj^ is a member of his famil}^; but 
the number and variety of other cases in which life insur- 
ance is provided is now large. In an increasing number of 
cases the beneficiary is the surviving business partner, a 
creditor, or a business corporation with an insurable in- 
terest in the life of one of its officers or employees.. ' ' Babe ' ' 
Ruth is said to be insured for $200,000 in favor of the 
owners of the ball club for which he wields his mighty bat; 
Mary Pickford, Charlie Chaplin, and Douglas Fairbanks are 
each insured for $1,000,000 in favor of the moving picture 
company, their "producer"; and one of the large motion- 
picture corporations insured the life of its managing head 
in 1921 for $5,000,000. This is said to be the largest life 
insurance policy ever written, and it was divided among 
six or more insurance companies. 

Life insurance has been much used by persons mainly 
dependent on labor incomes,^ salaries, professional fees, and 
active business profits, rather than from funded incomes. In 
essence and largely in origin it is a cooperative method of 
providing for survivors, by all in a group contributing a 
sum to be given to the families of those dying. Naturally, 

B See Vol. I, labor incomes, in Index. 



188 BANKING AND INSURANCE [Pt. II 

the need is most urgent in families not having accumulated 
wealth. It has of late been extended rapidly, as "indus- 
trial insurance" to wage-earners, in policies never exceeding 
$1000, but averaging very much less, often being for no 
more than enough to pay funeral expenses. The premiums 
on such policies are usually collected weekly and by agents 
making personal visits. The cost to the insured is, there- 
fore, necessarily high in proportion to the amount of insur- 
ance. 

§ 11. Assessment life insurance. Life insurance plans 
may be distinguished, with reference to the time and method 
of collecting the premiums, as assessment and reserve insur- 
ance. 

In the simplest form of assessment insurance the losses 
are paid by contributions taken after the losses occurred, 
each member paying an equal share without regard to age. 
In a slightly modified plan the assessments are made at the 
beginning of the year, based upon the expected mortality 
for the year. Life insurance of this plan is essentially like 
the mutual fire insurance already described, the percentage of 
risk for each policy, whether on persons or houses, being 
assumed to be equal to that of every other policy. The 
great variation in the chance of loss in the case of various 
forms of urban property makes simple mutual assessment 
fire insurance unsuitable in such cases, and even in the ease 
of farm buildings it has been increasingly seen that differ- 
ences in location, grouping, structural materials, nature of 
uses, condition of water supply, and other means for fight- 
ing fire, cause differences in risk which properlj?- should be 
recognized. This can be done by classifying risks and in- 
suring on a scale at lower or higher assessment rates. If 
some concession is not made to the better risks, some enter- 
prising commercial companies will see a profit in giving them 
a lower rate. Mutual companies which ignore these differ- 
ences feel the effects of "adverse selection" in that they are 
left with only the more hazardous property. 



Ch. 12] PRINCIPLES OF INSURANCE 189 

Now, in the case of life insurance the risk varies with 
great uniformity (considering the average mortality of large 
groups of men) according to the one factor of age. The coSl 
of assessment life insurance, therefore, is closely related to 
the average age of the memljers composing the group of in- 
sured. The rates are very low in a new organization with 
a membership of young men ; but each year the average age, 
and therefore the mortality of the membership, rises, and 
the annual assessments must be increased. By the constant 
addition of young members this rise of cost maj^ be retarded. 
But when these members grow older, a still larger addition 
of young members is required to keep down the average. 
But other young men are averse to entering the organiza- 
tion under these conditions; and the result is that the rate 
of assessment must be steadily increased. Finally failure 
results, or some form of "reorganization" that drives out 
the older members. The simple assessment plan carries with 
it the seeds of its own decay. 

To meet these difficulties in part, various modifications of 
the flat-rate assessment plan are employed, such as classi- 
fication by age, so that each member pays a flat rate according 
to age at entry; or large initiation fees at entry, which 
form a temporary "reserve" to offset increasing mortality in 
late years. Finally, the policies may be issued on the natural 
premium plan, by which the members of each age class pay 
exactly what the insurance costs for the year. Under this 
plan the company will remain solvent, but the annual cost 
to the insured rises so rapidly that many surviving members 
are forced to drop the insurance in later years. 

Assessment insurance is sold by stock companies organ- 
ized for profit, by fraternal orders, and by various types of 
miitual organizations. Many of the stock companies have had 
a dismal historj'- of hardship to surviving members and of 
eventual failure. They are reforming or disappearing under 
the influence of hostile legislation resulting from a better 
popular knowledge of insurance principles. The fraternal 



190 BANKING AND INSURANCE [Pt. II 

orders have more than ten million policies in force and in- 
comes totaling more than $180,000,000. They combine insur- 
ance with other objects of a benevolent and social character. 
With good management, a favorable death rate, and very- 
low expenses, some of them have provided protection at 
very low rates for many years. Many in the past have 
failed, with disappointment and disaster to the older members. 
'Still others are struggling with difficulties that presage dis- 
solution. Most of them now have some, though inadequate, 
reserve accumulations, and some have so improved their 
methods that they begin to resemble reserve companies. 
The assessment companies average $1.37 reserves per $100 of 
insurance in force, and get 10 per cent of their total in- 
comes from their funded investments. Even with the favor- 
able conditions under which fraternal orders conduct their 
insurance business, they eventually must fail unless they 
adopt rates and policies based upon adequate reserves. Many 
thousands of present members are paying for insurance at 
rates that will not suffice to meet the future losses. The 
assessment plan fails to eliminate the one great risk, that 
of leaving the survivors without insurance in advancing years. 

Eefekences. 

Gephart, W. F., Principles of insurance, vol. 2, Fire. N. Y. Mac- 
millan. 1917. 

Same, Insurance and the state. N. Y. Macmillan. 1913. 

Euebner, S. S., Property insurance. N. Y. Appleton. 1913. 

Willet, A. H., Economic theory of risk and insurance. N. Y. Long- 
mans. 1901. 
Winter, W. D., Marine insurance. Pp. 450. New York. McGraw- 
Hill. 1919. 

Zartman, L. W. (Ed.) Fire insurance. Yale Univ. Press. 1915. 



CHAPTER 13 



SCIENTIFIC LIFE INSURANCE 

§ 1. Reserve life insurance. § 2. The mortality table. § 3. The 
single premium for au}^ term. § 4. Level annual term premiums and 
reserves. § 5. Term policies and straight life. § 6. Limited premium 
payments. § 7. The endowment feature. § 8. The choice of a policy. 
§ 9. Insurance assets and investments as savings. § 10. Future of 
insurance. 

§ 1. Reserve life insurance. The plan of reserve insur- 
ance provides a remedy for the difficulties just indicated. 
The essential purpose of the reserve plan is to collect during 
the earlier years of the insurance policy, when the mortality 
is less, a sum larger than is needed to meet the current losses. 
This sum, the reserve, is kept invested and accumulating an 
income sufficient to offset the increase in losses as years ad- 
vance. In reserve insurance, therefore, the premium never 
increases from year to year, although it may be so arranged 
as to diminish or to cease entirely some time within the 
term for which the insurance continues. 

The premium must always be fixed in advance. The cal- 
culations for determining the premiums on different kinds 
of insurance policies are many and complex, but all con- 
form to a few general '^-inciples. The three factors assumed 
are an average mortality table, a rate of interest (or yield 
on investments), and an expense rate in proportion to the 
premiums on outstanding insurance. Insurance on the re- 
serve plan is often called scientific insurance because, upon 
the basis of these assumptions resulting from experience, it 
makes exact mathematical calculations of the premiums and 
reserves needed for insurance of any particular kind in re- 

191 



192 BANKING AND INSURANCE [Pt. II 

spect to age of insured, number of payments, method of pay- 
ing the beneficiary, and any other conditions. The premium 
thus fixed is, however, only a maximum, and usually is re- 
duced as the result of conditions more favorable than those 
assumed. 

§ 2. The mortality table, "When large numbers of men 
are taken as a group, a certain proportion of those at each 
age may be expected to die. A mortality table starts with 
a group of persons, as 100,000, at a given age, as 10 years, 
and shows the number who die and the number who survive 
at each year of age until all are dead. The tables generally 
used in the United States are the ' ' Actuaries ' ' which assumes 
the limit of life to be 100 years, and the American Experi- 
ence Table of Mortality, constructed by Sheppard Homans in 
1868, which assumes the limit of life to be 96, Some figures 
from the latter table, at specified years, are given below; 



I 



[.ge 


Number Living L 


deaths vnthin a 


Death rate 






year 


per 1,000 


10 


100,000 


749 


7.49 


20 


92,637 


723 


7.80 


30 


84,441 


720 


8.43 


35 


81,822 


732 


8.95 


40 


78,106 


765 


9.79 


50 


69,804 


962 


13.78 


60 


57,917 


1,546 


26.69 


70 


38,569 


2,391 


61.99 


80 


14,474 


2,091 


144.47 


90 


847 


385 


454.54 



95 3 3 1,000.00 

, The actual deaths in any group of insured are not exactly 
the number in the mortality tables. But this is not an es- 
sential difficulty as long as the deaths are fewer than the 
figures of the tables, at least in the earlier years of the 
policy. Any excess of premiums thus collected but increases 
the safety of the insurance or reduces the need of later pay- 
ments. In fact, the mortality in all well conducted companies 
in the United States is below the figures of these tables, 
partly because the tables were conservatively calculated, 
partly because of the favorable influence of medical selec- 



Ch. 13] 



SCIENTIFIC LIFE INSURANCE 



193 



tion, especially among the recently insured, and partly be- 
cause of the improvement in longevitj^ since the tables were 
constructed. 

The premiums given as illustrations in the following dis- 
cussions are "net premiums," or natural premiums, esti- 
mated as just sufficient to meet the actual payments required 
by the contracts in the policies. To provide for the ex- 
penses of management, an addition is made to the net 
premium, called the "loading." The entire premium is 



40-1 

35 

o 30- 

o 

" 25- 

i. 
<u 

°- 20- 
>. 

•~ 15- 
C9 



Mortality Rate 

American Experience 

Ages 35-65 




35 



40 



65 



45 50 55 60 

Age at beginning of year 

Fig. 1, Chapter 13, shows the rise of mortality rates between the 
ages 35 and 65, which calls for more and more rapidly increasing pay- 
ments under the simple assessment plan. 

called the "gross premium." The loading, a large part of 
which goes for agents' commissions and the costs of manage- 
ment, is a very considerable addition to the net premiums, 
adding in the case of the standard com.panies nearly 25 per 
cent to the premiums for an endowment policy, nearly 30 
per cent on a limited paj'^ment, and more than 40 per cent 
on a straight life. A part of this, however, may be re- 
funded to the insured in the form of "dividends." 

§ 3. The single premium for any term. It is apparent 
that the natural assessment premium (ignoring the factor 
of interest) for $1000 of insurance is expressed by the death 



194 BANKING AND INSURANCE [Pt. II 

rate for that year, e. g., at age 20 the payment of $749 by 
each of the 100,000 living at the beginning of the year will 
provide the $749,000 needed to pay the losses. If premiums 
are collected at the beginning of the year and losses are 
paid at the end of the year, and if interest can be earned 
meantime at the rate of 3% per cent, the premium in advance 
for a one-year term policy is the natural premium dis- 
counted, e. g., $8.64 is the present worth of $8.95, which is 
the natural premium at age 35 due a year later, interest 
being 31^ per cent. In these calculations there is no allow- 
ance for expenses, the necessary "loading." 

In the same manner may be determined the natural assess- 
ment premium for each year of insurance. It is a simple 
matter to determine the amount of a single premium, at any 
age, that is adequate to pay for insurance covering any 
selected number of years (term insurance) up to the entire 
period of each insured person's life (full life). It is neces- 
sary only to apply the formula of present worth and that of 
compound interest on investments.^ Thus the losses of any 
future year, according to the table of mortality, discounted 
by the rate of yield on investments, are the present worth 
of insuring the entire group for that year. The single 
premium for each of the insured for any term of years is 
the sum of the present worth of insurance for all the years 
of the term, divided by the number living at the beginning 
of the period.^ 

The payment in advance of the single premium for any 

1 See Vol. I, p. 279. 

2 Let P be the oresent worth of all the policies for a group of the 
same age, p the present worth of one policy, X the total insured at the 
beginning of the period, f the natural assessment premium this year, 
or the natural nremium reauired for any year. Then 

f f f f 

_ 1 2 n 

P rr _ + -^ 4- , _]_... 



P = 



(14-r) (I4-r)2 (l-fr)3 (i+r] 

JP 
X 



Ch. 13] SCIENTIFIC LIFE INSURANCE 19.-> 

definite term provides a reserve fund sufficient, on the as- 
sumptions made, to carry all the insurance without further 
pajTnents. Each year there is added to the fund the income 
earned on investments, and there is subtracted the amount of 
the losses for the year, until the death of the last member of 
the insured group. If the deaths in the earlier years are 
fewer than were expected in the mortality table, this will be 
offset eventually by more deaths at the advanced years; but 
in the meantime a reserve larger than was expected is yield- 
ing income, thus providing a larger sum than is needed to 
pay all the policies at maturity. This surplus might be dis- 
tributed as so-called ''dividends" from time to time to those 
surviving, or be added pro-rata, at intervals, to the amount 
of the policies as accumulated dividends. 

§ 4. Level annual term premiums and reserves. It is a 
matter of no very abstruse mathematics (in principle) to 
find the equivalent of this single premium in any one of many 
Qther forms of premium payment. The processes are but 
variations of present worth and compound interest calcula- 
tions. Such calculations, however, lead into many complexi- 
ties of practical detail difficult to explain in brief compass, 
and are the special task of the actuary (the mathematical 
expert dealing with such problems in the insurance business). 
The most useful actuarial equivalent of the single premium 
is the level annual premium for any period (term or lifel. 
Almost all policies now written have the level annual premium 
as a feature. The amount of the level annual premiums at 
first is ffreater than the losses: this causes for a time the 
steady accumulation of a reserve that yields income. Then, 
as the losses grow, they overtake and finally surpass tbfi 
amount of the annual premiums. Therefore, the total re- 
serve for any group of insured, within the definite term for 
which insured, increases year by year to a maximum and tlien 
declines until it reaches zero with the payment of the last 
claim. The individual reserve for each policy not yet 



190 BANKING AND INSURANCE [Pt. II 

matured increases steadily the longer it is in force, what- 
ever be the term. The total reserve is essential to the sol- 
vency of the company and the payment of all the policies 
as they fsill due. 

The companies that issue policies on the level premium 
plan or reserve plan are known as "old line" companies, or 
as "legal reserve" companies, because the state laws require 
every company of this type to maintain the reserves cal- 
culated on the basis of a certain rate of yield. The growth 
of the legal reserve companies in recent times constitutes 
one of the financial marvels of the age. They had in 1919 
more than 58,000,000 policies in force, for a total of nearly 
$36,000,000,000 of indemnity (insurance in force) ; their 
total income was nearly $1,600,000,000 (about one fortieth 
being from investments, the remainder from premiums), and 
their total assets $6,700,000,000. These figures grow so 
rapidly that any statistics are soon out of date. The up- 
ward curve may be seen in the following data: 

'Number of Amount of Total Total 

policies in force insnroMce in force income of year assets 

1890 ... 5,200,000 ...$4,049,000,000 ...$197,000,000 ...$771,000,000 

1900 ...14,400,000 ... 8,562,000,000 ... 401,000,000 ...1,742,000.000 

1910 . . . 30,000,000 . . . 16,407,000,000 . . . 781,000,900 . . . 3,876,000,000 

1919 ...58,300,000 ...35,515,000,000 ...1,557,000,000 ...6,743,000,000 

Reserve insurance is carried on by both mutual and stock 
companies; of late some large stock companies, such as the 
Equitable and the Prudential, have been transformed into 
mutual companies. The mutual company legally belongs to 
the policyholders, though its control is actually in the hands 
of a self-perpetuating group of trustees and officers, more 
or less supervised by state officials. The gross premiums 
in reserve insurance are, for the purpose of safety, fixed at 
a figure larger than the expected cost of the insurance, and 
normally the earnings from interest are higher, the mortality 
is lower, and expenses are less than those on which the cai- 



Cir. 13] SCIENTIFIC LIFE INSURANCE 107 

dilation of rates is based. From the excess of income result- 
ing, the company sets aside a surplus and then divides the 
rest among the policyholders. These returns, virtually but 
the refund of excess premiums, are called "dividends" (a 
somewhat misleading term, not to be confused with dividends 
on corporate stock) . The policies that receive dividends are 
called "participating" and are said to participate in the 
earnings. Formerly the majority of policies paid "deferred" 
dividends after five, ten, or twenty years, according to vari- 
ous tontine and semi-tontine plans, the survivors to these 
periods receiving their dividends plus those of the other pol- 
icyholders who had died or had withdrawn from the com- 
pany. This form of policy was objectionable in that it in- 
volved a lottery element, the survivors winning the "divi- 
dends" that should have been paid to the deceased; it was 
made illegal in New York and other states, and in most cases 
dividends are now paid annually. The stock company, or- 
ganized for profit, frequently charges lower premiums for 
"non-participating" policies, and then retains such profits as 
maj" result from keeping expenses below receipts.. 

§ 5. Term policies and straight life. A person purchas- 
ing life insurance, taking out a policy, finds himself facing 
a choice among a confusing variety of policy forms. Apart, 
however, from some comparative!}^ minor features such as 
those iust described, as to distribution of dividends, the 
various forms of policies result from combining in various 
ways three features. The first of these is the term within 
which the level premium is calculated. This may be one 
year, or any number of years, most frequently five or some 
multiple. Whatever be the term, the rate of premium is 
calculated with respect to the expected mortality at the 
ages included, and at the renewal of the insurance for a new 
term the premium rate "steps up" to that required to 
meet the expected losses at the higher ages. Evidently, the 
shorter the term for which a policy is written, the lower the 
rate of premium, for the early years, because the smaller 
the reserve needed to keep down payments in the later years 



108 BANKING AND INSURANCE [Pt. II 

of the term. For example, on a twenty-year term policy 
taken at age 35 tlie natural premium would be $10.80 a year. 
Break this term up into two terms of ten years each, and 
the annual premium for the first ten year would be $9.36; 
but when the policy is renewed for the second term of ten 
years (at age 45) the rate would be nearly $15.00. The policy 
known as ''straight life" or ''level life" is simply term in- 
surance for the term limit (or highest age) of the mortality 
table (in the American Experience table that is 96). The 
net premium for straight life at age 35 is $19.91, ajid this 
permits (at the rate of earnings assumed) the accumulation 
of a reserve of $310.75 at the end of twenty years, whereas 
the reserve on the twenty-year term ending then is zero. 
The income of this reserve, added to the annual premium, is. 
enough to meet the expected losses in the later years as they 
gradually rise. (These amounts are on the assumption of the 
American mortality and 3^ per cent interest.) 

§ 6. Limited premium payments. A second feature in 
which policies differ is in regard to the number of premium 
payments to be made according to the calculation. If the 
■number of payments is any less than the number of years 
of the term the policy is one of "limited payment." The 
most limited payment is the single premium already described, 
which may be used in connection with any term from one year 
to life. The single premium is simply the reserve required 
to meet the cost of the insurance, without further payments, 
;to the end of the term. The net single premium, or reserve, . 
for a straight life policy, at age 96 is $1000, the face of 
the policy. The most common limited payment policy is the 
twenty-payment life. The annual premium for this at age 35 
is $27.40, which is more than twice as much each year as the 
premium on a twenty-year term ($10.80) although it provides 
no more indemnity. But whereas the reserve on the term 
policy at age 55 is zero, the reserve on the twenty-payment 
life is $566.15, this being just the amount of a single-pay- 
ment life policy if taken at age 55. 

By just as much as the experience of any company (or 



Ch. 13] 



SCIENTIFIC LIFE INSURANCE 



199 



separate group of insured) is more favorable than the figures 
assumed as to rate of yield on investment, mortality, or ex- 
penses, there will be excess premiums to refund ("divi- 
dends"), which may be used by the insured to reduce his 
annual premiums or to purchase additional insurance or to 
add to the reserve. In the more successful companies an 
ordinary life policy eventually accumulates a reserve suffi- 
cient to carry the policy to the limit of age without further 
payments, and thus becomes in fact a limited payment policy. 



Net Premiums 
American Experience 3tPER Cent 

•*I000 reserve 



MO- 



*40.12 20 yr. endowment 




Fig. 2, Chapter 13. Comparisons of net premiums and of reserves on 
different types of policies. 

§ 7. The endowment feature. A third feature in respect 
to which life insurance policies differ is as to the extent to 
which they include the feature of saving with that of in- 
surance. We have seen that, just to the extent that any 
reserve whatever is accumulated to keep the premium level, 
to prevent its "stepping up" as the mortality rate advances 
with age, there is an act of saving distinct from the payment 
of a premium for insurance in that year. This is brought 
out clearly in the case of many insurance policies which pro- 
vide for a "surrender value" annually equal to the accumu- 
lated reserve. So, in our example, the reserve of the straight 
life policy was $310.75, and that of the twenty-payment life 
was $566.15. If the insured survives he may, according to 



200 BANKING AND INSURANCE [Pt. II 

the terms of many policies draw for his own benefit these 
amounts, the "surrender value." This privilege in many 
cases unfortunately defeats the purpose of insurance for the 
families, and tempts men to use the proceeds of their policies 
for enjoyment or for investment in business. 

A further step is taken in the savings process in endow- 
ment policies. In these the level premium for a definite term 
is made high enough to accumulate a reserve more than 
sufficient for a single-payment life policy beginning at the 
end of the limited payment period. The premium on endow- 
ment policies is so calculated that the reserve equals the 
face of the policy at the end of the payment period. For 
example, on a twenty-year endowment the net annual pre- 
mium is $38.35, the terminal reserve is $1000, which is the 
surrender value. Many persons are attracted to endowment 
insurance by the oft expressed thought that "You don't have 
to die to beat it." But this is a mistake. The endowment 
policy is merely a convenient but somewhat costly plan of 
saving, hitched on to an insurance policy, with which "actu- 
arially" it has no essential connection. In "scientific" in- 
surance the insured pays its full actuarial cost for each 
feature of the policy that he buys : so much for the insurance, 
so much additional for the accumulation of the endowment. 
The premium for endowment insurance is much higher than 
that for term life insurance alone during the same period. 
If insurance is the thing one needs, one is purchasing only 
a fraction as much for the same annual outlay. 

It will be observed that only the survivors to the end of 
the term get the endowment, and those dying earlier receive 
no more than if they carried the cheapest term insurance. 
This gives to the endowment policy a strong "tontine" or 
lottery character, the survivors profiting at the cost of those 
who die within the term. This often deceives the uninformed 
applicant for insurance into the belief that, despite the costs 
of management, an endowment policy yields a much higher 
return than other conservative investments at compound in- 
terest. The excess of the net endowment premium over the 



Ch. 13] SCIENTIFIC LIFE INSURANCE 201 

net term premium in our example is annually $26.65, which, 
compounded at 4 per cent, would be about $825 at the end 
of the period; but this is sufficient to give the survivors 
$1000 each, or approximately 6 per cent compound interest. 
The survivors are lucky not only in living but in getting 
a monetary prize (paid for by those who have died) for 
their success. All those who have died, however, would have 
been better off if they had taken out some cheaper form of 
policy (term, or straight life, or limited premium) and had 
deposited in the savings bank each year the difference in the 
premiums. 

§ 8. The choice of a policy. The choice of a policy by 
an applicant for insurance presents much difficulty in view 
of the manifold differences in the details of the various con- 
tracts, the contingent nature of so many features on which 
the ultimate cost will depend, and further because of the 
various circumstances of the insuring individuals, making 
different policies suitable to their different needs. Moreover, 
the advice of the agent is too often of little assistance, when 
it is given in view of the amount of his commission, and 
with the desire to make an immediate sale, rather than with 
regard to the true interest of the insured. The first condition 
of a wise choice is to get into a sound company, of which 
there are now many, for mere size does not necessarily in- 
dicate either superior soundness or superior economy in a 
reserve company. The various policies written by any hon- 
estly conducted reserve company are all actuarily equivalent 
on the basis of the assumptions made, and all provide re- 
serves adequate to meet their outstanding contracts. There 
are certain questions on which the applicant must be clear 
and which he alone can answer. 

( 1 ) What is it he most needs — is it the protection of insur- 
ance, or is it an opportunity to deposit savings regularly? 
The insurance method differs from the method of depositing 
savings by its contingent nature, the resulting income of any 
individual being possibly much greater than the amounts 
actually saved (e.g., when the insured dies or is injured 



202 BANKING AND INSURANCE [Pt. II 

soon after taking insurance), and possibly less or nothing at 
all. 

(2) What is the period within which insurance is most 
needed ? 

(3) How much can he devote to insurance or to saving 
respectively, and how will this amount probably change in 
the course of years, increasing or decreasing? The premium 
in personal insurance (life, accident, sickness, invalidity, old- 
age pensions) is in almost all cases paid out of some current 
income. The premium paid is just so much subtracted from 
the amount available for present direct use and applied to 
the purchase of future incomes for one's self or family. 

(4) What would be the most suitable mode and distribu- 
tion of indemnity payments? The payment usually takes the 
form of a lump sum payment at death or at the maturity of 
the endowment. In recent times there has been a growing 
use of original forms of payment which give to the bene- 
ficiary annual or monthly instalments for a definite number 
of years or for life. 

In the light of the foregoing discussion, it is apparent 
that the more immediate and greater the need of insurance, 
and the more limited the present income of the insured, the 
briefer the term for which insurance should be taken for the 
greater the amount of indemnity that can be bought with 
a given outlay. A young man in his twenties or thirties, 
with a limited salary or with his capital invested in business, 
needs particularly to protect his wife and his children until 
they are of age. The difficulty with term policies, especially 
for shorter terms, is the stepping up of premiums, which 
later makes the cost prohibitive. However, life insurance 
is essentially needed by one having dependents (wife, young 
children, sisters, parents, etc.), and is far less often impor- 
tant to the older man than it is to the man between twenty 
and fifty years of age. A good golden mean for many men is 
a twenty-payment life policy, its surrender value at age 
fifty-five being an endowment for nearly two thirds the face 
of the policy. The best general purpose policy for the active 



Cir. 13] SCIENTIFIC LIFE INSURANCE 203 

business man who can use and invest his funds safely and 
well is the ''straight life." A very desirable kind of in- 
surance (as yet little developed) for* salaried men is that 
terminating at some chosen retirement age, (say sixty-five 
years) combined with an old-age pension for life thereafter. 

§ 9. Insurance assets and investments as savings. Of all 
savings institutions insurance probably is destined to be the 
most important. It is probable that abstinence will more 
and more express itself not in accumulating large capital 
sums to provide for one's old age or for survivors, but in 
providing insurance for dependent survivors, and invalidity 
and old-age pensions for the insured and others, payable as 
terminable annuities. In any case, the results to be ex- 
pected in the changing forms and magnitude of private 
fortunes are certain to be great. The assets of life insurance 
companies in the United States have already attained the 
enormous sum of nearly $7,000,000,000, a sum equal to the 
reported savings bank deposits. In the last thirty years life 
insurance assets have more than doubled in each decade, and 
are now increasing by more than a quarter of a billion dol- 
lars annually. These great funds, which in equity nearly 
all belong to the policyholders, form already approximately 
one thirtieth of all the private capital of the country. They 
are invested in many ways, in real estate, in loans secured 
by mortgages on real estate, in bonds, municipal, railroad, 
and industrial. This is one of the ways in which the equit- 
able ownership of the wealth of the nation is being practi- 
cally and effectively socialized. The problem of wise legis- 
lation for these organizations, of their competent and honest 
management, and of their relation to the social, business, and 
political life of the nation, is certain to be of ever increas- 
ing importance. We are hardly more than emerging from 
the experimental stage of insurance, hardly more than at the 
beginning of its development. 

§ 10. Future of insurance. It is striking evidence of the 
importance of the marginal principle ^ that insurance should 



204 BANKING AND INSURANCE [Pt. II 

still be desired by men when the cost is so high and so large 
a part of the total premiums is absorbed in expenses. In- 
surance of all kinds grows apace, but its use would be wider 
and its benefits greater if the "tare and tret" of doing 
the business could be reduced. It seems a reasonable hope, 
now that the experimental stages are passed, that this may 
be done. It is true that some portion of the expenses of in- 
surance companies give to the insured valuable services, such 
as inspection of houses for fire prevention, medical examina- 
tion, and home nursing to reduce illness and conserve life 
and these services might be further extended. In the case 
of all kinds of insurance as yet a large expense for agents 
has been necessary to educate men to see the value of insur- 
ance and to purchase it, as well as for many other competi- 
tive expenses. It has been found that much of this expense 
can be saved by insurance in groups (for all employees in 
an establishment), by compulsory insurance (as of all work- 
ingmen), and by central state administration serving to reg- 
ularlize and unify the organizations. An important problem 
to be solved in the future is to find methods of insurance 
equal to or exceeding in their efficiency those now in use, but 
at much more moderate cost. It is not improbable that uni- 
versal cooperative state insurance, both of life and property, 
will be worked out. This important question will be further 
considered in connection with "social insurance" as a mea- 
sure to benefit the working classes. 
3 See ch. 12 § 6. , 

References. 

Dawson, M. M., The business of life insurance. New York. A. S. 

Barnes & Co. 1905. 
Gephart, W. F., Principles of insurance, vol. I, Life. New York. 

Macmillan. 1917. 
Huehner, S. 8., Life insurance. N. Y. Appleton. 1915. 
Zartman, L. W., (Ed.), Life insurance. Ed. Yale Univ. Press. 1915. 



PART III 
TARIFF AND TAXATION 



CHAPTER 14 



AMERICAN TARIFF HISTORY 



§ 1. Political and trade boundaries. § 2. Prevalence of protective 
tariffs. § 3. Specific and ad valorem rates. § 4. Some technical feat- 
ures of the tariff. § 5. The tariff, 1789-1815. § 6. The tariff, 1816- 
1845. § 7. The tariff, 1846-1860. § 8. The tariff, 1861-1871. § 9. The 
tariff, 1872-1889. § 10. Tlie tariff, 1890-1896. § 11. Th« Dingley 
tariff, 1897-1909. § 12. Sentiment favoring lower rates, 1908. § 13. 
The Payne-Aldrich tariff, 1909-1913. § 14. The Underwood tariff, 
1913. § 15. Operation of the tariff, 1913-1921. § 16. The return to 
high tariff, 1921. 

§ 1. Political and trade boundaries. By international 
trade is meant, in general, trade between persons resident in 
different countries; comparatively rare is the case in which 
one of the two parties to a trade is a whole nation acting 
through its government as a unit (e. g., in the purchase of 
munitions of war in neutral countries). Outside of a com- 
munistic group such as the family, trade is a necessary ac- 
companiment of division of labor. As territorial di\'ision of 
labor began between neighboring tribes,^ international trade 
was the earliest kind of regular interchange of goods. In- 
deed, the very word "market" meant originally the bound- 
ary between tribes. Thus, from primitive times when wan- 
dering savages gave bits of flint or copper in return for 
salt or fish, individuals have sought to adjust their goods 
to their desires through trade with men of other political 
groups. "With the progress of the world in the means of com- 
munication and transportation, international trade has 
widened in extent and grown in volume. 

Economic relations never have been coextensive with politi- 

1 See Vol. I, ch. 17, § 10. 

207 



208 TARIFF AND TAXATION [Pt. HI 

cal relations. The economic groupings of men connected by 
a network of trades never have and never will correspond 
very nearly with political groupings of men bound together 
by common citizenship in particular states. Indeed, it is 
not uncommon for many of the residents in two adjoining 
states to trade far more with each other than they do with 
their own fellow citizens. Lawmakers and rulers from the 
beginnings of formal governments have constantly tried to 
hinder this kind of trade. They have done this chiefly be- 
cause of their belief that they could .strengthen their states 
in political and economic ways, and could favor some of 
their citizens, by confining economic relations within politi- 
cal boundaries — if not exclusively, more closely than when 
trade was left to take its natural course, guided by individual 
motives. The regulation of international trade, therefore, 
has always constituted an economic problem of great impor- 
tance in the field of political action. 

§ 2. Prevalence of protective tariffs. For a century and 
a half most serious students of economics have favored a 
larger measure of freedom, if not absolute freedom, in for- 
eign trade. But the actual practice of most nations has 
never been in accord with the principles laid down by the 
philosophers. Great Britain alone among the larger coun- 
tries has, since 1846, steadily pursued a low-tariff policy for 
revenue only, and her example has been most nearly followed 
by Holland and Denmark. Germany, which had always had 
restrictive duties, adopted still more protective measures un- 
der Bismarck in 1879. France, Italy, and most of the other 
nations of Europe have strong protective tariffs. The United 
States has followed a restrictive policy since near the begin- 
ning of the last century. The explanation of this contradic- 
tion between precept and practice is not entirely simple. 
Great interests are affected by foreign trade, and certain 
of these interests are able to influence opinion and to dominate 
legislation. Free trade is not the most desirable thing for 
every one. The general policy of free trade between nations, 



Ch. 14] AMERICAN TARIFF HISTORY 209 

as advocated by most economists since Adam Smith, has 
usually been rejected by the people and the legislators. 

In its details American policy in tariff legislation under 
the Constitution has been varied and vacillating. The 
changes have been determined in most cases by motives of 
temporary partizan advantage or by the political activity of 
the immediate beneficiaries rather than by clear knowledge 
and consistent purpose of the electorate as a whole. Thus 
its lessons for the student are largely of a negative nature, 
but they well repay serious study. 

§ 3. Specific and ad valorem rates. Before entering upon 
the history of the American policy let us make clear the mean- 
ing of certain technical terms and explain certain methods 
that are frequently referred to. 

Rates (and duties) may be either specific or ad valorem. 
Specific duties are those that are calculated and levied ac- 
cording to some physical test, as so much per pound, per 
yard, per hundred-weight, or per ton. Ad valorem duties 
are those that are calculated and levied according to the value 
of the goods (usually as it was at the place of shipment), 
determined by an assessor, by invoice of sale, by statement 
of the importer under oath, eto. The actual duty collected 
on any article may result from various combinations of the 
two rates (as, to take an actual example, $4.50 a pound and 
25 per cent ad valorem on cigars and cigarettes) or ad 
valorem with a minimum valuation so that on the cheaper 
goods the rate is specific. 

Specific rates are more easil}^ applied in administration, not 
offering the temptation to undervaluation and misrepresen- 
tation that ad valorem rates do ; on the other hand, specific 
rates do not adjust themselves to price changes as ad valorem 
rates do. If the prices of goods go up the specific rate is 
relatively less and affords less of * ' protection ' ' to the domestic 
producer; whereas if prices go down (as, in general trend, 
the prices of manufactured goods have done most of the 
time) the specific duties are relatively greater. To take a 



210 TARIFF AND TAXATION [Pt. Ill 

historical example, the specific rate of 6^ cents a yard on 
cotton goods in 1816, which was at first in fact only about 
25 per cent, within a few years became about 75 per cent 
and absolutely prohibitive. For this reason specific rates 
have most often been used in acts intended to increase the 
''protective" duties and often "as a device for immediately 
raising rates; while ad valorem rates have been more often 
used in acts prompted by the desire for less drastic exclusion 
and for a more adequate revenue; but there is no essential 
connection between the protective policy and specific rates. 
Indeed, in the period from 1897 to 1909, when most prices 
were rising, many of the specific rates under the Dingley 
Act, intended to be strongly protective, afforded less and 
less ' ' protection. ' ' ^ 

§ 4. Some technical features of the tariff. All goods not 
subject to duties are said to be on the free list. It is custom- 

2 It is evident that it is only tlirough ad valorem rates that it is 
possible to compare the average rate of duty for one tariff act vpith 
that for another. As, however, every tariff act is made up of both 
specific and ad valorem duties, it is only at the end of the year that an 
average ad valorem rate can be estimated by comparing the total of 
duties collected vrith the total estimated value of the goods imported. 
Average ad valorem, rates are estimated in this way both on the dutiable 
goods alone, and on all goods, free and dutiable combined. There may 
be an element of error, even of misrepresentation, in such estimates. 
They do not give the simple test of the relative height of duties or of 
the degree of "protection" that we might at first suppose. Just to the 
extent that a new and higher rate really operates to exclude imports 
(and thus is protective in its effect) the goods subject to that rate 
cease to form part of the total imports. For example, if the average 
rate of duty were 25 per cent, and a 50 per cent rate on an article were 
increased to 75 per cent, it is possible that this rate would prove to be 
absolutely prohibitive. This raise of rate, therefore, would tend to 
reduce the average rates collected on all dutiable articles. Changes in 
general conditions of industry from causes quite apart from the tariff 
may result in shifting the proportions of imports that are dutiable so 
that the average rates go either up or down while the tariff law has re- 
mained unchanged on the statute book. A failure to consider these and 
related facts leads to much confusion in popular and political discussion 
of the tariff. 



Ch. 14] AMERICAN TARIFF HISTORY 211 

ary to group articles in schedules, of which there are fourteen 
in the law of 1913, designated from A to N (for chemicals, 
pottery, metals, wood, etc.), but the rates are not uniform 
for all the articles in each schedule. Drawbacks are a cer- 
tain amount, the whole or a part, of the duties that have been 
paid on imported commodities, which is paid back by the 
government on the reexportation of the goods. Compen- 
satory duties (or compensatory rates) are those levied on cer- 
tain manufactured articles with the purpose of raising their 
price as much as domestic producers' costs are raised by a 
tariff on their raw materials. Examples are a duty on 
woolen goods to offset a duty on wool, or a duty on shoes to 
offset one on hides. They may be intended to be partial or 
complete or more than sufficient, and are likely in any case 
to work either more or less to the advantage of the domestic 
producer than was intended. It may be that the conditions 
of supply are such that the home price of the raw materials 
is raised little or none by the tariff, while the price of the 
finished product is considerably raised, or vice versa. 

§ 5. The tariff, 1789-1815. The main difficulty of govern- 
ment in 1781-1789 under the Articles of Confederation was 
lack of the power to obtain revenues by taxation. The sep- 
arate states alone could levy duties, and a good many tariff 
restrictions on freedom of trade among them developed in 
this period. The Constitution established the principle of 
entire freedom of trade among the states. The first act of 
Congress under the Constitution levied a tariff, primarily for 
revenue purposes, but clearly having a protective purpose in 
the view of some of the representatives. However, most of 
the separate rates, as well as the general average rate, were 
the lowest ever levied by Congress, except that there was no 
free list and that 5 per cent was imposed upon all goods not 
otherwise enumerated. Ad valorem duties up to a maximum 
of 15 per cent (that on carriages) were laid upon certain 
articles of luxury, and low specific duties on a few articles 
such as glass, nails, iron manufactures, hemp, and cordage. 



212 



TAEIFF AND TAXATION 



[Pt. Ill 



From 1789 until 1812, thirteen tariff laws, all told, were 
passed. One after another many rates were raised to get 
larger revenues, but some goods were put upon the free list. 
The foreign trade, in both imports and exports, grew largely 
and with considerable regularity, rising then rapidly to a 
maximum in 1807. Then followed troublous times, with Brit- 
ish Orders in Council and our embargo and non-intercourse 
acts until 1812, and war until 1815, trade falling off at 
first one half, and at last (in 1814) to less than one twelfth 
of the former maximum. Just as trade was, in the war 
period, sinking to the vanishing point, the tariff rates were 
doubled in hopes of getting increased revenues needed for 
the war, but in vain. 

§ 6. The tariff, 1816-1845. Though rates had been rising, 
manufacturers had been making efforts to secure higher rates 
for protection, even as early as 1803. Effectual exclusion of 
foreign goods and consequent stimulus to the establishment of 
manufactures in the eastern states resulted, in the period 
1808-1815, from the embargoes and the war. On the re- 
turn of peace, imports were resumed on a large scale and the 

Fig. 1, Ch. 14. Imports into the United States 
Many statistics bearing upon tariff history are graphicallj' brought to- 
gether here. This figure should be carefully studied in connection with 
the following sections. Observe how invariably in the years following 
a crisis, tlie amounts of dutiable imports and of duties collected have 
diminislied, whether the tariff meantime was changed or not. 



S300 
^20CH 

o 

3 

S 100-1 
200 
300-1 



IMPORTS INTO THE UNITED STATES. 
1821-1865 

T T 




t T 



FISCAL TEAS JAH. 1-DEO. Slip FISCAL TEAS I JDLT l-JDITE 30 



T = Tariff change C = Crisis 
1830 1840 



War 



1850 



1860 



Ch. 14] 



AMERICAN TARIFF HISTORY 



213 



call for a higher tariff was loud. In the revision of 1816. 
rates in a number of cases were tixed higher than those before 
the war. Average rates are said to have been about 20 per 
cent. The rate on both cotton and woolen goods was 25 per 
cent (and the minimum on cotton goods was a specific rate of 
6l^ cents a yard). High rates were imposed on pig iron (50 
cents a hundred), hammered bar (75 cents a hundred), and 
rolled bar ($1.50 a hundred, equivalent to about 100 per cent 
ad valorem). Rates were raised 
on many other articles. The av- 
erage ad valorem rates collected in 
1821 attained the remarkably 
high figures of 36 per cent on 
dutiable goods, and almost 35 per 
cent on free and dutiable to- 
gether. 

In 1824, in response to the grow- 
ing sentiment in favor of the so- 
called "American policy of pro- 



.1800- 



IMPORTS INTO THE UNITED STATES. 

T - T 




:^800 



214 TARIFF AND TAXATION [Pt. Ill 

tection, ' ' many rates were still further increased, as 
those on cotton goods and woolen goods (to 33% per 
cent) and some kinds of iron. Cheap wool was now 
taxed 15 per cent, and that valued over 10 cents a 
pound at 20 per cent (to be 30 per cent after 1826). 
In 1828, in the ''tariff of abominations," which evoked 
much bitter criticism, the rates on all these goods 
were again raised, those on woolen goods being in some 
cases 100 per cent on the value, and those on iron be- 
ing from 40 to 100 per cent on the value, and duties were 
levied on molasses, hemp, and flax. The results appear in 
the statistics of 1830, showing the average ad valorem rates 
on dutiable imports to be nearly 49 per cent, and on free and 
dutiable together to be over 45 per cent. This marks a 
temporary high point in tariff rates. Revenues were then be- 
coming excessive, and that year the rates on tea and coffee 
and some other goods were reduced. 

Violent protests, especially from the South, were made 
against the protective system, and the tariff became a more 
important political issue. Then in 1832 a number of changes 
were made, mostly downward; the iron tariff, for example, 
being reduced to about the level of 1824. Average rates 
were thus brought down to about 33 per cent on dutiable 
goods. The compromise tariff act of 1833 provided for a proc- 
ess of reduction during a period terminating in 1842, the 
cut to be small at first, then to be made more rapidly to 
bring the maximum rate on any article down to about 20 
per cent.^ These changes, while as yet incompleted, had, 
in 1840, brought the average rates on dutiable goods down 
to but 30 per cent and on free and dutiable together to 15 
per cent. The 20 per cent rate, however, remained in effect 
only two months in 1842, when it was replaced by a tariff 

3 Usually given as 20 per cent. However, a good many rates under 
the full operation of the act worked out as 211/2 or 23 per cent, and a 
few at 26 and at 29 per cent. Besides, there were numerous specific 
rates, the ad valorem force of which cannot be determined. 



Ch. 14] AMERICAN TARIFF HISTORY 215 

with higher rates distinctly protective, passed by the Whig 
party, and which remained in force four years. 

§7. The taxiff, 1846-1860. The Democratic party, com- 
ing into power, passed the act of 1846, called the Walker 
tariff after the Secretary of the Treasury. As he was a 
believer in free trade, this act is often mistakenly described 
as a free-trade measure. It was, in truth, far from that. 
Most of the rates were, indeed, lower than those that had 
been in force between 1816 and 1846 (with the exception of 
those between 1840 and 1842), but still some of the rates 
were high (a few as high as 100 per cent) and many of 
them were strongly protective in nature. The fact that tea 
and coffee were on the free list is marked evidence that con- 
siderations of revenue did not dominate. The rate on cot- 
ton goods w>as 25 per cent and the rates on many of the 
most important other protected articles (iron, woolen goods, 
manufactures of iron, leather, paper, glass, and wood) were 
30 per cent. The average rates under the act for its last 
eight years (to 1857) were on dutiable 26 per cent, on free 
and dutiable 23 per cent. The country prospered for eleven 
years under this tariff. In 1857 rates were again reduced, 
the more important protective rates from 30 per cent, to 
a level of 24 per cent. This time partizan considerations 
played no part in the discussion. The revenues of the gov- 
ernment had been excessive and the need of a reduction was 
admitted by nearly every one. The average ad valorem 
rates under the nearly four years of the act of 1857 were 
about 20 per cent on dutiable and 16 per cent on free and 
dutiable (the lowest in the century between 1812 and 1913). 

§ 8. The tariff, 1861-1871. The reduction of rates in 
1857 was made just at the time when the country was at the 
height of a wave of prosperity and of speculation which cul- 
minated in the financial crisis of that year.* As always at 

* The political argument that the small tariff reduction of 1857 
caused the crisis of 1857 will not bear serious examination. See ch. 
16, § 13. 



216 Tariff and taxation [Pt. hi 

such time, the government's revenues fell greatly. The first 
purpose in the revision, of the tariff in 1861 was simply to 
restore the rates in the act of 1846. But the Morrill act, 
which became a law just before Fort Sumter was fired upon, 
contained many higher rates and its purpose was avowedly 
protective. This necessarily involved a sacrifice of possible 
revenues for the government-^ Then from the beginning of 
the Civil War till its close some rates were raised almost 
every month with little scrutiny or debate. The average ad 
valorem rate jumped from 19 per cent on dutiable in 1861 
(under the law of 1857) to an average of 35 per cent in the 
three years, 1862-1865. 

The most important tariff acts of the war were those of 
1862 and 1864, by which large increases were made on many 
articles. These tariff acts were passed in connection with 
far-reaching and burdensome applications of internal revenue 
taxes on many kinds of manufactures. The tariff rates were 
primarily intended to offset these taxes, "to impose an addi- 
tional duty on imports equal to the tax which had been put 
on the domestic articles," as was said by the sponsors of the 
bill. These rates were similar in purpose to compensatory 
rates, and in many cases they were more than sufficient to 
offset the internal taxes. Under the last of these acts the 
duties collected in the six years from 1865 to 1870 averaged 
nearly 48 per cent on dutiable and nearly 44 per cent on 
free and dutiable. 

V The remarkable fact was that soon after the war the in- 
ternal revenue taxes began to be repealed one after another, 
and by 1872 nearly all those bearing upon general manufac- 
tures (apart from cigars and alcoholic beverages) were gone. 
The tariff, however, remained almost unaltered. This re- 
peal of internal revenue taxation had the same "protective" 
effect as raising the tariff rates by so much. As if this were 
not enough for the protected interests, in 1867 the duty on 
woolens was further raised, and in 1870 numerous other in- 

5 See ch. 16, § 2. 



Cii. 14] AMERICAN TARIFF HISTORY 217 

creases were made in the duties having a protective character. 
Some reductions were made, but these were almost all on 
articles of a distinctly "revenue" character such as tea, 
coffee, sugar, molasses, spices, wines! Revenues were super- 
abundant for current expenses of government, and although 
there was a large national debt, hardly any of it was re- 
deemable at the time. There was therefore need to reduce 
taxation, but the attention of the consuming and tax-paying 
public was distracted by the somewhat passionate issues of 
the day. Besides, the public had not the technical knowl- 
edge or the unified opinion on this subject to protect itself 
against the greedy lobby in this process of tax revision. And 
so, selfish commercial interests could get nearly what they 
asked for in Congress, and politicians at Washington, who 
had come to have a well-nigh superstitious faith in the 
efficacy of very high protective duties, could quietly use the 
opportunity to raise the people's taxes for the people's good. 

These virtual increases in the protective power of the 
rates in force are not evident in the statistics of average 
ad valorem rates, because the higher rates in many cases 
were sufficient to exclude relatively more of the foreign 
products to which they applied.** The imports came, by a 
process of selection, to consist more largely of goods subject 
to lower rates. So the year 1868 showed the highest aver- 
age rate on dutiable goods (48.6 per cent) of any year after 
the act of 1828 until that of 1890, and the rate fell somewhat 
each year until in the fiscal year 1872 it was 41.3 per cent. 

§ 9. The tariff, 1872-1889. In 1872 the country was again, 
as in 1857, nearing the crest of a wave of prosperity and of 
speculation. Imports and customs receipts attained new 
high points in our history, and, despite the enormous reduc- 
tions of internal revenue taxation, the government's receipts 
continued to be excessive." The important revenue articles, 

6 See above, § 3, note 2. 

7 Internal revenue receipts in 1866 had been $309,000,000; in 1872 
they had fallen to $131,000,000, yet the government's surplus for the 



218 TARIFF AND TAXATION [Pt. Ill 

tea and coffee, were then transferred to the free list, as 
were also raw hides and paper stock and some other articles; 
the rate on salt was reduced one half and that on coal almost 
as much. Many other specific rates were reduced and the 
ad valorem rates on a long list of articles were cut to "90 
per cent of existing rates." The effects of these reductions 
were mingled with those of the severe financial panic occur- 
ring in 1873 and of the depression following, which reduced 
especially the importation of luxuries bearing the higher 
rates. The average rate of the three (fiscal) years 1873 to 
1871 was 39 per cent on dutiable (a fall of 9) and 28 on 
free and dutiable (a fall of 16). The ratio of imports enter- 
ing free, which in 1872 was still only about 1 in 14, became 
the next year 1 in 4. But government revenues falling 
short in 1874, advantage was soon taken of the circumstances 
to repeal in 1875 with little discussion the horizontal cut 
of tariff rates made in 1872. The specific rates that had been 
reduced in 1872 were little changed, however. From 1876 
to 1883 (8 fiscal years) nearly a third of the imports con- 
sisted of goods on the free list. The average rate on dutiable 
was over 43 per cent, and on free and dutiable 30 per cent. 
The tariff was a leading issue in the campaigns of 1876 and 
1880. In 1876 the Democratic party's platform contained a 
plank for ' ' a tariff for revenue only. ' ' It was a time of great 
industrial depression, and, as is usual in such cases, a large 
number of electors held the party in power responsible for 
business adversity (as in turn they credit it with any more 
or less fortuitous prosperity). The Republican candidate 
Hayes, after a long contest in Congress, was declared elected 
by a margin of one electoral vote. His opponent, Tilden, had 
received a quarter of a million more votes in the country 
as a whole. In 1889, when business prosperity was rapidly 

three years 1870-1872 was little less than $100,000,000 a year. This 
was almost half of the total receipts from customs, which were 
$216,000,000. 



Ch. 14] AMERICAN TARIFF HISTORY 219 

returning, the party in power was successful by a goodly 
margin of votes in the electoral college, though having a 
bare plurality of the popular vote. Garfield, the Republican 
candidate, was known as one of the more moderate protec- 
tionists, and his opponent, General Hancock, who was with- 
out any political record, declared the tariff to be a "local 
issue," to be determined in the Congressional districts. The 
tariff issue was thus not very sharply drawn. The tragic 
death of President Garfield left no clear leadership. The 
tariff question from 1876 to 1884 was politically in the dol- 
drums. 

Yet there was undoubtedly a somewhat growing popular de- 
mand for some moderation of the very high duties. To 
this demand the friends of protection who were in power 
felt compelled to concede something — or to appear to do so. 
Congress appointed a Tariff Commission of which the chair- 
man was secretary of the wool manufacturers' association, 
and after a report the tariff act of 1883 was passed. The net 
results were almost nil. Some rates were lowered, while 
others were raised with a definite protectionist purpose. The 
average rates for the next seven years, 1884-1890, were 45 on 
dutiable (an increase of nearly 2 per cent) and 30 on free 
and dutiable (unchanged as compared with the period end- 
ing 1883). In 1884 the Democratic party elected its presi- 
dential condidate (Cleveland) and a majority of the House, 
but as it did not control the 'Senate it could not pass any of 
the various proposed measures for a "reform" of the tariff. 
In 1888 the protective principle was a leading issue in the 
campaign. Although Cleveland received a few ten thousands 
larger popular plurality than he had obtained four years be- 
fore, and held the electoral votes of eighteen of the states, 
he lost New York and Indiana by very narrow margins, a 
result in which other issues played a large part. Harrison 
was elected, and the party favoring a high protective tariff 
came into power. 

§ 10. The tariff, 1890-1896. The tariff act (known as the 



220 TARIFF AND TAXATION [Pt. Ill 

McKinley Act) of October, 1890, followed. This was a gen- 
eral extension of the principle of protection. The rates on 
woolen goods were on the whole increased and made in more 
cases prohibitive. The rates on wool were increased. The 
rates on iron, which was already highly protected, were little 
changed except by the increase of the duty on tin-plates. 
The duty on sugar (in the main a revenue duty, yielding 
$55,000,000 a year) was removed and a bounty was granted 
to domestic sugar producers. In the next three (fiscal) years, 
1892-1894, the average rate proved to be more than 49 per 
cent on dutiable (4 per cent increase) and 22 per cent on 
free and dutiable (the remission of sugar duties accounting 
for the most of this fall of 8 per cent from the average under 
the preceding law — 4 per cent fall from the last year of its 
operation) . Particularly noticeable, however, was the increase 
in the proportion of goods entering free, which was nearly 
55 per cent of all merchandise, as contrasted with about 33 
per cent between 1884 and 1890. 

Again the political weather-vane shifted. The month after 
the McKinley Bill became law, the Congressional elections 
(November, 1890) returned an overwhelming Democratic ma- 
jority in the House, although this was a period of business 
prosperity, a fact usually favoring the party in power. In 
1892, Cleveland, being again a candidate, was successful over 
Harrison by a largely increased plurality of the popular vote, 
and received almost double the electoral vote of his oppo- 
nent. The House was Dem,ocratic, and the Senate soon be- 
came so. Business prosperity was rising again to a high 
(level, but there were many features of financial and specu- 
lative weakness in the situation, intensified by growing fear 
of a cheap money (silver dollar) inflation under the act of 
1878 providing for the annual purchase of silver, A finan- 
cial panic occurred in September, 1893, six months after 
Cleveland's inauguration. 

Nevertheless Congress enacted the next year, August 28, 
1894, the Wilson tariff act (named for the Congressman who 



Ch. 14] AlklERICAN TARIFF HISTORY 221 

introduced the bill). The changes made by this legislation 
were not on the whole very great, but were nearly all in 
the direction of the lowering of the tariff. Most notable was 
the putting of raw wool upon the free list. Some rates on 
woolen goods were reduced, but hardly more than enough to 
offset the effects, upon manufacturers' costs, of the reduction 
of the tariff on raw wool. Likewise small reductions were 
made on cotton and silk goods, on pig iron, steel and tin-plate, 
and many other articles; and larger reductions on coal, iron 
ore, chinaware, and glassware. To make up for the expected 
reduction of receipts from other sources, a duty was laid 
again upon raw sugar, and an income tax was passed (this 
soon, however, to be declared unconstitutional). 

Under this law, for three fiscal years (1894-1897) the 
average rates were 41 per cent on dutiable and 21 per cent 
on free and dutiable, — pretty high rates. The proportion 
entering free under this act was actually less than under the 
McKinley Act, partly because of the sugar item, and partly, 
probably, because of general business conditions. 

§ 11. The Dingley tariff, 1897-1909. The campaign of 
1896 was waged almost solely on the issue of free silver. 
Undoubtedly great numbers of voters supported William Mc- 
Kinley rather despite of, than because of, his high-protec- 
tionist beliefs. But his inauguration was promptly followed 
by the passage of the Dingley Act of July 24, 1897, which 
embodied a marked increase of protective rates. A duty 
was again levied on wool, and also on hides, which had been 
untaxed since 1872. High rates were made for woolens, 
linens, silks, chinaware, and the rate on sugar was doubled. 
Provision was made for some reduction of rates by reciprocity 
agreements, but the conditions were so complex that the 
effect could not be great. This high protective tariff, thus 
enacted without popular discussion, remained almost un- 
changed for twelve years, the longest life, by one year, of any 
tariff' act in our history, while other issues absorbed public 
attention — the Spanish War, colonial policy, "imperialism," 



222 



TARIFF AND TAXATION 



[Pt. Ill 



railway rate regulation, corporation control, etc. The rate 
under the first full fiscal year of the operation of the Dingley 
tariff, 1899, was the highest on dutiable in our history, 52 
per cent, and was nearly 30 per cent on free and dutiable. 
In practical operation, however, the average rate steadily 
became more moderate because of the rapid rise of the gen- 
eral price level that was in progress throughout this period, 
amounting to 35 per cent from 1898 to 1909.^ The average 
rate of duties collected for the period of twelve years was 
47 per cent on dutiable and 26 per cent on free and dutiable. 



50 



Tariff F ercentages 



A. Bate of Duties €ollfctf 




Fig. 2, Chapter 14, shows the average rate of duties collected under 
the Dingley Act, 1897-1909, the Payne-Aldrich Act, 1909-1913, and the 
Underwood Act, 1913-1920. 

It was steadily falling, and the last year, 1909, was 43 per 
cent on dutiable and 23 per cent on free and dutiable. 

§ 12. Sentiment favoring lower rates, 1908. While the 
Dingley Act was thus in operation showing declining average 
rates, sentiment was developing in every part of the coun- 
try in favor of a further moderation of the tariff. This 
was due partly to the discontent resulting from steadily ris- 
ing general prices, in which change the rise in the prices 

8 See above, § 3. 



Cji. 14] AMERICAN TARIFF HISTORY 223 

of food and of many other necessities was not fully com- 
pensated by the rise of the wages and incomes of the masses. 
Partly the growth of this sentiment accompanied the agita- 
tion against trusts and the belief that protective duties in 
some cases were an aid to the formation of domestic monop- 
olies. But, more fundamentary, this changing sentiment was 
the result of the changing industrial conditions in America. 
The character of our foreign trade had altered greatly since 
the early nineties. We were importing relatively less and 
less of manufactured and finished products, and more of raw 
materials ; and we were exporting less and less of raw materi- 
als and more of finished products. A growing number of 
manufacturers were feeling the need of cheaper raw materi- 
als and were looking hopefully toward an enlargement of 
their foreign trade. 

In view of the changing public sentiment, the Republicans 
in the campaign of 1908 admitted that the protective tariff 
needed to be revised, but they declared that it should be 
revised by its friends. It was doubtless the general under- 
standing that "revision" in this promise meaiit' revision 
downward, though this was left somewhat unclear in a cam- 
paign wherein the tariff played a somewhat minor part. The 
Republican platform formulated a new rule for maintaining 
"the true principle of protection," namely, that it "is best 
maintained by the imposition of such duties as will equal the 
difference between the cost of production at home and abroad, 
together Math a reasonable profit to American industries." 
This rule though fallacious, is very attractive in its sugges- 
tion at the same time of the idea of a moderation of the 
tariff and of an exact practical (not to say scientific) stand- 
ard for the determination of the proper rate in every case.^ 

§ 13. The Payne-Aldrich tariff, 1909-1913. The tariff 
act of 1909 was the attempt of the successful party to re- 
deem its campaign promises in regard to the tariff. Many 
changes of rates were made, both downward and upward. 

9 See § 12 in ch. 16. 



224 



TARIFF AND TAXATION 



[Pt. Ill 



It was estimated that rates were reduced in 584 instances, 
affecting 20 per cent of imports. These changes included 
placing hides upon the free list (taxed 15 per cent before,) 
and cutting down the rate on leather, shoes, coal, lumber, 
iron ore, pig iron, and steel-rails. But on the other hand 



Million Dollars 
eooo 




130 8 10 II 12 13 '14 '15 '16 
Fig. 3, Chapter 14, is a continuation, on a different scale, of Figure 
1 (seven years, 1909-1915, overlapping, to make comparison easier). 
The increased valuations from 1916 to 1919 reflect mainly price in- 
creases, and the enormous increase in 1920 evidences, in addition, the 
strenuous, yet inadequate effort of the rest of the world to keep on 
trading with us without getting more deeply into debt. The dates 
are for fiscal years. 

rates were increased in three hundred instances (including 
many items in the cotton schedule). The general belief that 
little reduction was effected, on the whole, was confirmed by 
the experience under the act. As compared with the last 



Ch. 14] AMERICAN TARIFF HISTORY 225 

two years (1908-1909) of the Dingley tariff the first two 
years of the Payne-Aldrich tariff showed a decline of 1.5 
per cent, and on free and dutiable a decline of less than 3 per 
cent. These reductions in the statistical results are no 
g-reater than occurred within like periods while the Dingley 
Act continued in operation without change.^" 

Probably no tariff since "the act of abominations" in 1828 
has called forth more widespread criticism than this one, and 
the tariff became a leading issue in the campaign of 1912. 
After 1910, The House being Democratic, many bills to re- 
duce duties were presented, and some were passed by both 
houses; but all were vetoed by President Taft, mainly on the 
ground that it would be best to await the report of the 
tariff board which had been authorized and appointed for the 
purpose of ascertaining the cost of production referred to in 
the "true principle of protection." 

§ 14. The Underwood tariff, 1913. After President Wil- 
son was inaugurated, March 4, 1913, the tariff was at once 
taken up by Congress. The general features of the act that 
was passed were as follows : 

(a) Considerable additions to the free list of raw materi- 
als. 

(b) Abolition of compensatory duties corresponding with 
the old rates on raw materials. 

(c) Keplacement of specific b^^ ad valorem rates in many 
cases. 

(d) Taxation of plain kinds of goods less than fancy kinds 
— luxuries higher than necessities. 

(e) Reduction of rates generally (most of the few in- 
creases being to correct some apparent error in the old 
law), 

10 Probably resulting from the rising prices, as explained above, § 3. 
For example, in one year, from 1899 to 1900, the average ad valorem 
rate collected on dutiable goods fell 3 per cent, and that on all goods 
fell 2 per cent; in tlie two years from 1904 to 1006 the average rates on 
dutiable fell 4 per cent and on all goods fell 2 per cent. See Fig. 2, 
ch. 14. 



226 TARIFF AND TAXATION [Pt. Ill 

(f) Application of the so-called competitive principle to 
rates intended to be protective, viz., to leave the rate just 
barely high enough to keep out foreign products.^^ 

Articles placed on the free list were raw wool (which had 
borne a rate equivalent to about 44 per cent), metals, agri- 
cultural implements, raw sugar (the lower rate to go into 
effect gradually), coal, lumber, many agricultural products 
including live cattle, meats, wheat, corn, flax, tea, and hemp, 
and numerous manufactures including boots, shoes, gun- 
powder, wood pulp, and print paper. 

Moderate reductions were made in the schedules for chemi- 
cals, earths, cotton goods, and sundries, while rates on various 
luxuries were either unchanged or raised. Left almost un- 
changed were the schedules for tobacco, for spirits and wines, 
and for silks (already very high). 

This act was signed October 3, 1913, and had been in opera- 
tion about nine months when the great war broke out in 
August, 1914. "What its effects would have been under more 
normal conditions we can judge little from the actual ex- 
perience. 

§ 15. Operation of the tarifT act, 1913-1921. The revi- 
sion of the tariff of 1913, viewed with non-partizan eyes, 
appears to have been carried out as consistently with regard 
to its professed doctrine, and as little influenced by the ma- 
levolent arts of the old-time Congressional lobby, as any 
debated tariff act in our history. It still contained, on the 
whole, a large measure of protection, evidenced by the fact 
that in the first eight months that the act was in operation 
the ad valorem rate on dutiable goods was but 4 per cent less, 
and the average rate on free and dutiable together was about 
3 per cent less, than in the preceding year. Apparently this 
was far from a "free-trade tariff." The reduction in the 
average rate collected was less than was expected. Many of 
the reductions had little effect, the former rate having been 
much higher than was needed to exclude the goods. In other 

nOn this see further ch. 15, § 5, § 6; ch. 16, § 12. 



Cn. 14] 



AMERICAN TARIFF HISTORY 



227 



cases the old rates were but nominal and inoperative because 
they were upon goods regularly exported, not imported 
(e.g., farm products, cotton goods, and some other manufac- 
tures). But some of the reductions doubtless would have 
forced the less efficient plants in some industries to increase 
their efficiency or go out of business. Time, in any normal 
period, is needed for adjustment, but an adjustment of a most 
abnormal kind was in progress during the war. Imports 




1913 1914 1915 1916 1917 1918 1919 1920 



Fig. 4, Chapter 14, shows the rapid growth of our foreign trade in 
the period of the World War, and the still greater relative growth in 
the excess of exports. The data are for fiscal years, ending June 30. 

from Europe fell somewhat, while total imports (after 1915) 
increased, and exports increased enormously. Old indus- 
trial establishments were converted to different and temporary 
uses. The comparatively low duties had no harmful effect, 
and enabled our trade to adapt itself far more quickly to 
international conditions and to profit more by the great oppor- 
tunities than could have been possible with a high tariff. 



228 TARIFF AND TAXATION [Px. Ill 

§ 16. The return to hig^h tariff, 1921. With the ending of 
warfare in November, 1918, began to be heard anew the ag- 
itation for higher dutiesi. Some indnstriesi, such as the 
chemical, which had sprung up during the war, saw their end 
if, and when, German trade was resumed. The financial de- 
pression about the middle of 1920 further stimulated the 
demand from many quarters for a return to high protective 
duties to ' ' give employment to our labor. ' ' The demand for 
a prohibitive tariff is always heard at such times. Our pre- 
diction made in 1916 was that ^^ the conclusion of the war 
must bring a new readjustment that must cause a severe shock 
to some enterprises and this must have been so under any 
possible variety of tariff, for such changes are logically re- 
lated to the subject of financial crises rather than to that of the 
tariff. ^^ Further it was said at that time: ''Under various 
pretexts, such as the danger of a flood of cheap goods after 
the close of the great war, .attempts will be made to make the 
tariff still more prohibitive. If the attempt is made through 
temporary rates to reduce the shock of the trade adjustments, 
of the 'dumping' after the war, then the devising and admin- 
istration of such measures should be delegated to an expert, 
disinterested, permanent tariff board. The task is to prevent 
temporary 'unfair competition' and sudden changes, rather 
than to raise permanent barriers to fair trade," 

The sweeping victory of the Republican party in November, 
1920, was probably aided in some part by the belief that 
higher protective duties would remedy the situation. Agri- 
cultural interests were particularly hard hit by falling prices 
due to the closing of European markets because American 
credit was suddenly withdrawn. So temporary acts provid- 
ing for higher duties on both manufactured and agricultural 
products were passed in 1921, and the country moves again 
toward a period of higher duties. 

12 First edition of this work, pp. 236, 238. 

13 See below, ch. 16, § 13. 



Ch. 14] AMERICAN TARIFF HISTORY 229 

References. 

Johnson, E. R., Tan Metre, T. W., Huebner, G. G., and Ha/nchett, 

D. 8., History of domestic and foreign commerce of the United 

States. N. Y. Carnegie Inst. 1915. 
McKinley., Wm. Tariff: a review of the tariff legislation, 1812-1896. 

N. Y. Putnam. 1916. 
Sumner, W. G., History of protection in the United States. N. Y 
' Putnam. 1877. 
Taussig, F. W., How tariffs should not be made. A. E. Rev., I: 

20-32. 1911. 
Taussig, F. W., Tariff History of the United States. 6th ed. N. Y. 

Putnam. 1914. 
Same. Free trade, the tariff, and reciprocity. Kew York. 

Macmillan. 1920. (A collection of the author's articles and 

speeches of the last 15 years.) 



CHAPTER 15 



INTERNATIONAL TRADE 

§ 1. Benefits of international trade. § 2. Erroneous views of benefits. 
§ 3. Relatively advantageous industries. § 4. Persistence of differences 
between nations. § 5. Doctrine of comparative advantages. § 6. Ad- 
vantages confused with monetary costs. § 7. Equation or international 
exchange. § 8. Balance of merchandise movements. § 9. Cancelation 
of foreign indebtedness. § 10. Par of exchange. § 11. International 
monetary balance and price levels. 

§ 1. Benefits of international trade. International trade 
is carried on by individual traders in any two countries. 
What motive impels men to trade across the political bound- 
aries of a state? The simple answer is that each trader has 
something to give and desires to get something in return. 
Each is seeking to get something that has to him a greater 
value than the thing he gives, and he believes he can do 
this in trade with a foreigner better than by trading at 
home. In any trade, both parties gain, or think they are 
gaining.^ In international trade there is the same chance 
for mistake as in domestic trade, but no more. In a single 
transaction in either domestic or foreign trade one party may 
be cheated, but the continuance of trade relations is depen- 
dent upon continued benefits. The once generally accepted 
maxim that the gain of one in trade is the loss of another is 
now generally rejected, but often still it is assumed to be 
true of international trade. The starting-point for the con- 
sideration of this subject is in this proposition: Foreign 
trade is carried on by individuals, for individual gain, with 
the same motives and for the same benefits as are found in 
other trade. 

1 See Vol. I, ch. 5, § 1 and § 7. 

230 



Ch. 15] INTERNATIONAL TRADE «31 

The advantages of international trade are indeed but those 
of division of labor in general, in the particular case where 
it happens to cross political boundaries. The great ter- 
ritorial divisions of industry are determined first and mainly 
by natural differences of climate, soil, and material resources. 
Thus trade arises easily between North and South, between 
warm and frigid climates, between new countries and old, 
between regions sparsely and regions densely populated.- 

Territorial divisions of industry are determined, secondly, 
by social and economic differences such as those with re- 
spect to accumulation of wealth, amount of lendable capital, 
invention, organization and intelligence of the workers, and 
the grade of civilization. 

§ 2. Erroneous views of benefits. Certain erroneous ex- 
planations of the advantages of foreign trade may be dis- 
missed with brief mention. It is said to give vent for sur- 
plus production and to give a wider market to what would 
otherwise go to waste. This involves the same fallacy as the 
"lump of labor notion," the destruction of machinery, and 
the praise of waste and luxury.^ If it were true that sale 
to backward nations were now necessary to give an outlet 
for products that would otherwise rot in the warehouses, a 
time would come at length when the world would have an 
enormous surplus unless neighboring planets could be suc- 
cessively annexed. Again it is said that the great purpose 
of foreign trade is to keep exports in excess of imports, so 
that the money of the country may constantly increase in 
amount. The ideal of such theorists is an impossible condi- 
tion where the country would constantly sell and never buy.* 
In the narrow commercial view of the subject the sole object 
of foreign trade is to afford a profit to the merchants, regard- 
less of the welfare of the mass of the citizens. 

§ 3. Relatively advantageous industries. Foreign trade 

2 See Vol. I, ch. 6, § 11, on the origin of markets. 

3 See Vol. 1, chs. 36 and 37. 

* Recall ch. 3, in general, on the nature of monetary demand. 



232 TARIFF AND TAXATION [Ft. Ill 

normally imparts increased efficiency to the productive forces 
of each country. In most cases it is apparent that labor 
is more effective and gets a larger product when it is ap- 
plied in those ways for which the country is best fitted and 
for which it offers the best and most bountiful materials. 
When two countries are somewhat differently situated, such 
as an old country like England and a newer country like 
the United States in the nineteenth century, the relative ad- 
vantages of various industries in the two countries are very 
unlike. The newer country excels in its broad area, its 
abundant rich lands, its bountiful natural resources of forests 
and mines. These are the superior opportunities that give 
the economic motives for settlement and for continued im- 
migration from other lands. Most of the newcomers find it 
to their advantage to develop the peculiar opportunities of 
the new land, rather than to go on producing the same things 
in the same way as they did in the old country.^ Thus 
they get a larger quantity of products per day's labor, and 
are able to gain by trading a part of these for the products 
of the older country. Thus the characteristic industries 
of the two countries must differ. Further, when special 
branches of industry have developed at one place, they make 
possible the advantages of large production and of high 
specialization. Without any government supervision, there- 
fore, but simply through the choice of enterprises, each citizen 
seeking the best occupation and best investment of capital 
for himself, industries are developed in which each country 
is either most markedly superior, or least inferior to its 
neighbors. If either laborers or capitalists in the new coun- 
try were to turn to the less-favored industries they would be 
forced to accept a smaller reward than they can earn in the 
more favored. 

§ 4. Persistence of differences between nations. If both 

5 See Vol. I for numerous statements of the effects of varying quan- 
tities of agents upon the economy of utilization; e.g., pp. 138, 163, 164, 
213, 228, and chs. 34 and 35 entire. 



Ch. 15] INTERNATIONAL TRADE 233 

men and wealth interchanged between industries and between 
countries with perfect readiness and without any outlay what- 
ever for transportation, these differences would soon disap- 
pear, and perfect equilibrium of advantage would everywhere 
result. In every country, in every occupation, labor and 
wealth of given quality and amount would receive the same 
reward. But the interchange of labor and of products be- 
tween countries is never without friction. 

The laborers, enterprisers, and investors in a naturally rich 
country are thus in a position of more or less enduring ad- 
vantage relative to those of older and poorer countries. Dif- 
ferences of the same nature appear as between different parts 
of the same country, as between the northern and the south- 
ern states of the American Union, between the eastern and 
the western states, and even between neighboring towns in 
the same state. The differences between two countries, how- 
ever, are likely to be more marked, the circulation of factors 
being so active within a country that it is allowable to 
speak broadly of prevailing national rates of wages, of in- 
terest, and of profit. Although, as Adam Smith said, ' ' a man 
is of all sorts of luggage the most difficult to be transported, ' ' 
the higher wages in a new country attract constantly from 
the older lands a portion of their laborers. The higher rate 
of interest in new countries constantly attracts, investments 
from abroad ; yet, despite these forces working toward equal- 
ization, the inequality may remain aiid, through the work- 
ing of other influences, may even increase in the course of 
years. 

§ 5. Doctrine of comparative advantages. It may be 
that two countries both possess the necessary technical con- 
ditions for making both articles that are to be traded for 
each other. It may even be that the people in one country 
would be able to make not only one of the two objects of trade, 
but both of them, more easily and with less sacrifice and effort 
than the people in the other. If, for example, American 
labor can produce two bushels of wheat in a day and English 



234 TARIFF AND TAXATION [Pt. Ill 

labor but one bushel a day ; and American labor can produce 
just as mucb iron in a day as English, labor — or more — the 
question always arises: Is it not foolish and wasteful not 
to produce both the wheat and the iron? 

Now, exactly the same case is presented in almost every 
simple neighborhood trade. The proprietor may be able to 
keep his books better than does the bookkeeper whom he 
employs. The merchant may be able to sweep out the store 
better than the cheap boy does it. The carpenter may be 
able to raise better vegetables than can the gardener from 
whom he purchases. Yet the merchant does not turn to 
sweeping and the carpenter to raising vegetables, because if 
they did they would have to quit or limit by so much their 
present better-paying work, and would lose far more than 
they would gain. 

So whenever the people in one country have a greater ad- 
vantage in one article than in another, relative to another 
country, the foreigners, like the low-paid man, will be willing 
to exchange at a ratio that will make it profitable to specialize 
in the product wherein the greater superiority lies. 

As an example, suppose that a day's labor in country A 
will secure two bushels of wheat (2x) and two hundred 
pounds of iron (2y), whereas in B a day's labor will secure 
Ix or 2y. Jhen A's comparative advantage in producing 
X becomes a reason for A's not trying to produce y. Trade 
can take place (aside from transportation outlay) at any ratio 
between 2x^2y (A's minimum) and 2x = 4y (B's maxi- 
mum). Evidently at any rate between these two ratios each 
party would gain something by the trade, e. g., at 2x:^3y A 
would get 3 instead of 2y by a day's labor, and B would get 
ly^x instead of Ix for a day's labor (2x for ll/o day's labor 
instead of for two days'). There can be no motive for trade 
unless the ratio of exchange is such as to enable the producers 
in each country to get somewhat more goods by specializing 
than they could get by applying their labor and resources to 
both kinds of products. 



Cir. 15] INTERNATIONAL TRADE 235 

§ 6. Advantages confused with monetary costs. The doc- 
trine of comparative advantages is always a hard doctrine 
for the j)opular mind, and particularly for the commercial 
mind endeavoring to carry on a business that cannot be made 
to "pay" in the face of foreign competition. It is easy to 
believe that a country ought not to import goods unless it 
is at an absolute disadvantage in their production. It is 
often declared that as our country can produce any kind 
of goods "as well" as foreign countries (meaning with as few 
daj^s' labor), there is a loss on every unit imported. The 
fundamental principle of trade as applied to such cases shows 
that not the advantage which one country enjoys over the 
other as to a single product determines whether it will gain 
by producing at home, but the comparative advantages en- 
joyed in the production of the two articles in question. 

The difficulty of clear thinking in this matter is increased 
by the fact that this theory usually has been, and still is, 
presented under the name of "the doctrine of comparative 
costs." Tlie word "costs" is very misleading in this con- 
nection, because it is now generally applied to enterpriser's 
outlay. It seems best, therefore, to replace it in this phrase 
hj the word "advantages." Of course, it never can be true 
that an article can be "profitably" imported when its monetary 
costs (all things considered, freights, insurance, merchant's 
profit, etc.) are higher in the exporting than in the importing 
country. Indeed, the importation of any article is proof con- 
clusive that the importer thinks that the monetary costs of 
an article are higher in the importing than in the exporting 
country. 

How does it happen that the monetary costs of any par- 
ticular goods in one country are higher than those of another 
country? The answer to this can be made only in the light 
of the equilibrium theory of prices.^ "Monetary costs" are 
but the prices reflected to agents from the products which 

See, e. g., Vol. 1, pp. 71, 162, 213, 227, 399-404, 438. 



236 TARIFF AND TAXATION [Pt. Ill 

thej'^ aid to produce. The relatively short factor in each of 
the trading countries is priced higher, the relatively long 
factor is priced lower, than in the other country. For ex- 
ample, agricultural land in England is priced higher (in 
grains of gold) per acre than equally good land in America, 
and an ordinary day 's labor in America is priced higher than 
similar labor in England. The manufacturer in America who 
is trying to manufacture something in which the labor ele- 
ment is large has to go into the labor market and pay higher 
wages than his English competitor just because there are 
other industries that can afford to outbid him for that labor ; 
whereas the English farmer trying to produce wheat finds 
that he has to pay land rent per acre much higher than his 
American competitor in North Dakota whose wheat is sold 
in Liverpool. These differences in relative prices within 
each country have important effects in the degree of inten- 
siveness of utilization of economic agents, both human and 
material. Men often speak carelessly as if America were a 
country of uniformly high prices, compared with Europe, 
but that is because they are thinking only of the kinds of 
goods that we import. American (wholesale) prices of the 
things we export to Europe are lower than European prices ; 
if they were not the things could not profitably be exported. 
These facts and principles are contrary to much of the pop- 
ular and political opinion with regard to protective tariffs. 

§ 7. Equation of international exchange. Foreign trade, 
of course, can take place as barter, and in earlier times very 
commonly did so. But in the existing monetary economy 
nearly all trades are expressed in terms of monetary prices. 
It was shown in the last section that both the prices of all the 
particular objects of international trade and the general 
levels of prices in any two trading countries come to be pretty 
definitely interrelated. Changes in the one country at once 
compel readjustments in the other. To understand in the 
most general way how this occurs, a knowledge at least of 



Ch. 15] INTERNATIONAL TRADE 237 

the elemetary principles of foreign exchange is required, and 
to this we may now turn. 

Let us begin with the proposition known as the equation 
of international exchange, which is sometimes given thus : 
The vaUiation (that is, the estimated total price) of the im- 
ports of a country must in the long run equal the valuation 
of the exports. But this proposition (especially the words 
"imports" and "exports") must be understood in a much 
broader sense than that of the movements of merchandise 
merely. The proposition might better be expressed : the total 
credits in international trade, created by whatever means, 
by a nation (including money actually sent abroad) must 
constantly just equal its total debits (including money im- 
ported) . Into the balance of accounts between any two nations 
enter many items : the cash values of the imports and ex- 
ports of merchandise ; freights, insurance premiums, and com- 
missions; the expenses of citizens while traveling abroad; 
money brought in or taken out by immigrants; the cost of 
the governmental foreign services (such as the salaries of 
consuls and of diplomatic representatives) ; subsidies and 
war indemnities received from or paid to foreign nations ; the 
investments of foreign capital; and credit items of many 
kinds on both sides of the account. 

The effect of loans upon the equation differs at differeiit 
periods, according as they are just being made, are continu- 
ing, or are being repaid. When foreign capital is first in- 
vested in a country, whether it is lent to the government 
or to individuals or to corporations, either gold must be re- 
mitted to the borrowing country or goods be sent. But later 
the interest payments and the eventual repayment of the 
principal of the loan act in the opposite direction. Accruing 
interest must be oft'set annually by exports from the debtor 
country, and the repayment of the principal requires that 
either money or goods be exported equal in value to the orig- 
inal obligations. In popular opinion an excess of exports of 



238 



TARIFF AND TAXATION 



[Pt. Ill 



merchandise is an index, if not the real cause, of national 
prosperity ; but evidently it is no true index whatever on this 
point. An excess of exports may at any given moment indi- 
cate that the country is rich and is lending abroad, or that 
it is in debt and is paying interest, or that it is repaying the 
principal. On the other hand, an excess of imports may in- 
dicate either that a country is poor, and is borrowing from 
abroad, or that it is rich, with many foreign investments, and 
is receiving the income from them in the form of a regular 
shipment of goods from the debtors. 

The following statistics of the foreign commerce (merchan- 
dise imports and exports) of the principal countries of the 
world are given in significant groupings which call for vari- 
ous explanations. As the war altered all the lines of com- 
merce, these figures are retained as illustrating the principle 
and the normal conditions better than could recent figures. 



COUNTRIES HAVING EXCESS OF 
IMPORTS OF MERCHANDISE EXPORTS OF MERCHANDISE 



United King- 
dom .... 
Germany . . , 
Netherlands 
E'rance .... 
Belgium ... 

Italy 

Aust.-Hunff. . 
Switzerland 

Spain 

Sweden . . . 
Denipark . . 
Norway . . . 

Canada 

China 

Turkey . . . . 



Excess 


Im- 


Ex- 


% 


ports. 


ports. 


57 


2,886 


1,835 


20 


1,824 


1,523 


30 


1,130 


873 


12 


1,089 


975 


33 


642 


484 


68 


562 


334 


7 


487 


457 


44 


287 


200 


10 


168 


153 


26 


163 


129 


16 


191 


165 


58 


101 


64 


34 


298 


222 


43 


254 


178 


59 


135 


85 



United States . 
Russia 

British Colonies 
British India . 
Australasia . . 

Japan 

Cuba 

Mexico 

San Domingo . 

Argentina .... 

Brazil 

Chile 

Uruguay 

Bolivia 

Venezuela .... 



Im- 
ports. 



1,312 
436 



558 

418 

242 

196 

84 

78 

5 



263 
172 
98 
35 
21 
10 



Ex- 
ports 



1,638 
542 



615 
486 
302 
206 
116 
115 
10 



353 

214 

116 

37 

24 

15 



Excess 

% 



25 

24 



5 
16 
25 
5 
40 
42 
100 



34 
24 
18 
6 
14 
50 



Figures are in million dollars ($1,000,000) and are mostly for the 
year 1908. (Statistical Abstracts, 1908, p. 769.) 



§ 8. Balance of merchandise movements. The first group 
apparently consists of the older, creditor countries which are 
drawing some of the income of their investments from abroad 



Ch. 15] 



INTERNATIONAL TRADE 



239 



each year in the form of food and of raw materials of many 
kinds. The second group includes countries of very diverse 
conditions, possibly all having some investments abroad; 
Italy receives large imports in return for the services of many 
Italians working in foreign countries, and the three Scandi- 
navian countries (especially Norway) carry on a large com- 
merce for other nations which is paid for in these ways. The 
excess of imports in the third group probably is the result of 
new investments that were being made in Canada by Eng- 

AvERAGE Balance of Mdse. Trade of the P. 8 




I82M8J7 



1850- 1873 1874-1895 1896-1914 



Fig. 1, Chapter 15, shows the average balance of merchandise trade 
of the United States in various periods, the columns below indicating 
excess of imports in the period, those above indicating excess of ex- 
ports. 

lish and American capitalists, in Turkey especially by Ger- 
mans, and in China by Americans and Europeans. 

The countries in the second column are doubtless on the 
whole debtors, but in varying degrees. The excess exports of 
some are insufficient even to pay all the current interest, and 
they are borrowing still more (possibly the British colonies, 
Japan, and several South American countries) ; others have 
ceased to borrow and are simply paying interest ; whereas the 
United States at least with its excess of exports was at this 
time both paying intere.st and getting out of debt. With the 



240 



TARIFF AND TAXATION 



[Pt. Ill 



outbreak of the war in 1914 the United States began rapidly 
buying up its foreign-held securities, and became a creditor 
nation. Its imports must therefore in future more nearly 
equal if not exceed its exports, the actual outcome being de- 
pendent as well on various other items in the balance as on 
those here considered. 

§ 9. Cancelation of foreign indebtedness. In the inter- 
national business of any two important countries to-day, 
such as England and America, the number of credit and 



Balance of Mdse Exports from U. 8. 1896-1920 
b'li.st : iBii.s 




Fig. 2, Chapter 15, shows in more detail, by years for 1896 to 1914, 
on a different scale, the facts for which Figure 1 shows only the aver- 
ages. 



debit transactions is enormous. If each trader had to at- 
tend to the forwarding of the means of payment for his pur- 
chases, he would, of course, deduct from the amount of his in- 
debtedness the amount due him from his foreign correspond- 
ent, and might from time to time "remit" the balance in the 
form of a shipment of gold. This simple offsetting and can- 
celation of debits and credits would greatly limit the amount 
of gold that would have to be shipped. But still, under such 
conditions, there must be a very large number of shipments 
of gold by different individuals, and a large proportion of 



Ch. 15] INTERNATIONAL TRADE 241 

these shipments would be going in opposite directions at the 
same time. Now, a merchant in New York called M may 
have a balance to pay in London to X, and at the same time 
a merchant in London called Y have a balance to pay in 
New York to a man called N. If M can buy from N his 
claim in the form of an order, draft, or bill of exchange, and 
send it to X, the latter may through his bank collect the sum 
from Y. In this way a further cancelation of indebtedness 
would occur. 

When all persons having either debits or credits to be paid 
in New York and in London, respectively, are dealing with 
the banks in these cities, and the banks and special exchange 
brokers are constantly buying and selling these bills, a mar- 
ket is created for London exchange in New York (and con- 
versely in London), and a much easier and more nearly com- 
plete cancelation of indebtedness results. In effect, all the 
debits and credits between the two countries are merged into 
one big ledger balance, and the international shipment of gold 
bullion finally made is just the amount needed to balance the 
accounts payable at the time. Industrial indebtedness is 
represented in various forms : bills of lading for goods 
shipped, drafts made by the creditor on his debtor for goods 
shipped or property sold, checks or letters of credit for trav- 
elers, bonds and notes public and private. These are the ob- 
jects dealt in by the bankers who are tlie agents to carry on 
the work of exchange. 

The balance of foreign exchanges is of essentially the same 
nature as the domestic cancelation of indebtedness. It is 
going on constantly between the two merchants in the same 
town, between two banks in the same town who represent 
groups of merchants, between men in neighboring towns, and 
between distant states like New York and California." The 
price of exchange to the individual is reduced by the special- 
izing of the business in the hands of a few dealers, permitting 
the cancelation of indebtedness or offsetting of exchange, and 

6 See ch. 7, sec. 8. 



242 TARIFF AND TAXATION [Pt. Ill 

greatly reducing the amount of bullion to be transported in 
making the paj^onents. The cost to the bank of providing this 
exchange for its customers varies as conditions change, but in 
any case is not great, so that in domestic business when any 
charge is made it is usually at a fixed rate, and is mainly for 
the service, 

§ 10. Par of exchange. Foreign exchange from America 
to Europe is, however, in two features different from domestic 
exchange: (a) the cost of shipment of gol'd is greater; (b) 
the monetary units of the two countries usually differ in 
name, weight, and fineness, and sometimes in materials. "We 
may define foreign exchange as the purchase and sale of the 
right to receive a given kind and weight of metal or its mone- 
tary equivalent in current funds at a specified time and place, 
or as the funds so purchased. Par of exchange between two 
countries using the same metal as a standard is the number 
of units of the standard coin of the one country that con- 
tains the same amount of fine metal as the standard coin 
of the other country. There is no fixed par of exchange 
between gold-using and silver-using countries; par of ex- 
change between them fluctuates with changes in the compara- 
tive values of the two metals. The gold-shipping points for 
importing or exporting gold are respectively par of exchange 
plus or minus the cost of moving the actual metal. These 
points vary with means of transportation and communication. 
The par of exchange between New York and London being 
nearly $4,866 and the cost of expressing and insuring a gold 
pound between New York and London being approximately 
$.02,^ the shipping point for the export of gold from New 
York is $4,886 and for the import of gold to New York is 
$4,846. At these upper and lower limits, there is a motive 
for shipping gold as a commodity. 

"When large sales have been made to Europe and credits 

7 This varies also with conditions ; after the outbreak of the war 
in 1914 it was for a time as hi^h as $.05 because of high war rates of 
insnranee. 



Cir. 15] 



INTERNATIONAL TRADE 



243 



are accumulating in New York and the importation of gold 
is imminent or already begun, the claims are bought by bank- 
ers in New York at less than par. At such a time one need- 
ing to remit a sum to London can buy exchange for less than 
par, for every such draft remitted reduces London's indebted- 
ness and, by so much, the need of shipping gold to this coun- 
try. As a rule, then, accumulating credits here mean a low 



5 0- 
40- 


^--. 






-SO 

-40 


30- 


M ajd r i \d 






-30 


20- 


/■V.-'' 






-20 


10- 


,'1B'u e n o/fe^\A i re s^y_. 


-^ 




-10 


- 


./je>^ -A, /\.-''^—^'^r~'^ W-vA-.'C' 


^^-cr-' 


-? — ^i 




10- 


— ' 'Fa'r iT" 




\ 
\ \ 


-10 


20- 




\ 


' \-^ 


-2 


30- 




\ 


^ 


-30 


40- 




New York Rate of Exchange 


\ 
\ 


\ 


-40 


50- 


1914-1919 


-50 


6(y 


















-60 
-7 






1914 


1915 


1916 


1917 


1918 


1919 


1920 



Fig. 3, Chapter 15, shows the variation of New York rates of foreign 
exchange with four financial centers in the very abnormal period from 
1914-1920. Exchange below par (0) indicates large purchases from 
the United States, (the case of English and French exchange from the 
end of 1914). Exchange above par (Spain and Argentine, 1917-1919) 
indicates large purchases by the United States while the embargo pol- 
icy was in effect (see Chapter 6). 

rate of exchange, accumulating debits a high rate of ex- 
change from this to the foreign country. 

These are the merest rudiments of the subject. The many 
problems arising, such as the adjustment of foreign credits to 
changing needs, and such as arbitrage (the readjustment of 
the rates of exchange prevailing among different financial 
centers), make foreign exchange both a complex science and 
a difficult art. 



244 TAKIFF AND TAXATION [Ft. Ill 

§ 11. International monetary balance and price levels. 

The balance of all accounts for or against a country (includ- 
ing new loans, current interest, and repayments) must thus 
eventually be settled in money. This cannot fail to effect 
the general level of prices in both countries, though this is 
brought about often only in indirect and gradual ways. The 
flow of money out of a country causes the loan market of 
a country to tighten (interest and discount rates to rise) in 
proportion as the reserves of the banks are reduced. Then 
"general prices" begin to fall.^ When prices fall, imports 
decline, as the country is not so good a place in which to 
sell : when prices rise, imports increase, as it is a better place 
in which to sell. The opposite effect is produced on exports, 
and thus in a short time the national credits and debits 
are again brought into equilibrium. A slight movement of 
money in either direction is enough to influence prices and 
set in motion forces to counteract a further flow of money. 
Decade after decade the circulating medium of leading coun- 
tries changes very slightly in amount, and the fluctuations 
in its amounts during periods of so-called "favorable bal- 
ance of trade" and of "unfavorable balance of trade" are 
only the smallest fraction of the value of goods passing 
through the ports of the country. 

It is therefore absurd to imagine, as is sometimes done, 
that a country could continually import goods until it was 
drained of all its money, or that by any possible set of de- 
vices it could forever have an excess of exports to be paid 
for by a continual inflow of gold. Long before either of such 

8 The connection between a high rate of interest and falling prices 
is a dynamic phenomenon of a very temporary nature. In long-time 
static conditions the general level of prices and the prevailing rate of 
interest are dependent on entirely different sets of forces. See on the 
theory of interest, Vol. I, p. 308. In long-time movements of prices, in 
contrast with brief changes due to foreign trade such as are referred to 
above, high rates of interest are connected with rising prices, and vice 
versa. See above, ch. 6, § 12, on fluctuating price levels and the 
interest rate. 



Ch. 15] INTERNATIONAL TRADE 245 

movements could go far, the automatic readjustment of inter- 
national prices would inevitably check it, and secure and re- 
tain for each country its due portion of the money. 

References. 

Bastable, C. E., The theory of international trade. N. Y. Mac- 

millan. 1903. 
Brovm, H. G., International trade and exchange. N. Y. Macmillan. 

1914. 
Clare, G., The A B C of the foreign exchanges. N. Y. Macmillan. 

1895. 
Escher, Franklin^ Foreign exchange explained. N. Y. Macmillan. 

1917. 
Goschen, Viscount, The theory of the foreign exchanges. N. Y. 

Scribner. 1898. 



CHAPTEK. 16 



THE POLICY OF A PROTECTIVE TARIFF 

§ 1. Military and political motives for inteference with trade. § 2. 
Revenue and protective tariffs. § 3. Growth of a protective system. 
§ 4. The infant-industry argument. § 5. The home-market argu- 
ment. § 6. The "two-profits" argument. § 7. The balance-of-trade 
argument. § 8. The claim that protection raises wages. & 9. Tariffs 
and unemployment. § 10. Exports and exhaustion of the soil. § 11. 
Protection as a monopoly measure. § 12. Equalizing "costs of produc- 
tion." § 13. Tariff legislation and business depressions. § 14 Harm 
of sudden tariff reductions. § 15. Some lessons from our tariff history. 

§ 1. Military and political motives for interference with 

trade. The considerations set forth in the last chapter raise 
a strong presumption in favor of the sovereign state permit- 
ting its citizens to trade freely across its. boundaries, as the 
best way to further their own prosperity and, on the whole 
and in the long run, that of the nation. Indeed, this pre- 
sumption and belief has been held by nearly all serious stu- 
dents of the question, with more or less of modifications and 
qualifications, ever since Adam Smith published his work on 
the "Wealth of Nations" in 1776 .^ But in conflict with this 
belief has been the all but unanimous policy of nations from 
early times, throughout the Middle Ages, and down to this 
day,^ of interposing some special hindrances (of varying de- 
grees and kinds) to this kind of trade. Sometimes this has 
been done by prohibitions, but more often by taxes imposed 
upon either imports or exports. Sometimes the attempt is 
made to justify the policy of governmental interference with 
foreign trade by arguments which crumble before the slight- 
est examination, and again it is admitted that free trade is 

1 See ch. 3, § 12 and § 13. 

246 



Ch. 16] THE POLICY OF A PROTECTIVE TARIFF 247 

true ill theory, but it is declared to be false in practice. The 
latter view is not to be entertained for a moment. If free 
trade in theory (as an explanation) is complete and true, it 
will in practice (as a plan of action) be sound and workable. 
In truth, however, the practical policy of governmental inter- 
ference with foreign trade has always in part rested on other 
than simple economic grounds. 

Interference with free trade with the foreigner has always 
been in large measure due to political motives. In every 
petty medieval state or self-governing city, the aim was to 
make the economic boundaries coincide as nearly as possible 
with the political boundaries. Except for the trade in a few 
articles of comparative luxury, this aim was at that time 
nearly attainable. The peasantry surrounding a fortified 
town and enjoying its protection were compelled to trade 
there. Down to our own time it has seemed to statesmen ex- 
pedient to forbid or discourage trade that might nourish the 
economic power of future enemies. Sometimes governments 
have used embargoes, bounties, or tariffs as weapons to injure 
the trade of other nations and to secure diplomatic or com- 
mercial concessions. Often they have sought by tariffs to 
encourage the building of ships and the manufacture of arma- 
ments and of all kinds of munitions by private enterprise 
within their own borders, even when the immediate cost of 
these products was greater than if they were purchased 
abroad. In such cases it is always a question whether an 
outright expenditure would not be better, whether the govern- 
ment could not build its own arsenals and shipyards more 
economically than it can foster private enterprise by means 
of a protective tariff. However, the political (or military) 
argument for protection recognizes that it is in itself a costly 
(not a profitable) policy, and that the cost is justified only 
on the grounds that military necessity warrants the outlay. 

The military argument as applied to the preparation of 
ships and munitions has no application to a tariff on those 
articles that have no bearing upon military power. But 



248 TARIFF AND TAXATION [Pt. Ill 

the most recent application of chemistry, physics, and the 
mechanical arts to the uses of war has given new significance 
to a larger policy of industrial preparedness for military 
purposes. The year 1914 probably ushered in for the world 
a new epoch of protective and discriminatory tariff legis- 
lation determined by political rather than by direct economic 
considerations. Yet it is possible that if the nations agree to 
limit armaments they will, at the same time, move toward 
freer trade and the open-door policy. 

§ 2. Revenue and protective tariffs. An important dis- 
tinction in principle is to be made between a tariff for rev- 
enue and a tariff for protection. A revenue tariff is a 
schedule of duties on goods entering or leaving a country, 
so arranged that the collection of taxes may cause the least 
possible disturbance to domestic industry. 'Speaking gen- 
erally, the duties may be on either imports or exports; but, 
as export duties are unconstitutional in the United States, 
our tariff discussions are concerned only with import duties. 
The purest type of revenue tariff is one touching only articles 
that, even at the higher prices, are not in the least to be 
produced profitably in the home country, A good example 
is that of England with most of the duties levied on tropical 
products. 

A protective tariff is a schedule of import duties so ar- 
ranged as to give appreciably higher prices to some domestic 
enterprises than they could obtain with free trade. It shuts 
out some foreign goods that would otherwise enter, and in 
so far it "protects" the domestic producer from the foreign 
competitors who would sell at lower prices than those at 
which he can or will sell. In other words, ''protection" 
means governmental interference with the freedom of trade. 

The distinction between revenue and protective tariffs, 
thus clear in principle, is not always easy to make in prac- 
tice. It does not lie in the intention of the taxing power, but 
in the actual effects produced. Most tariffs combine the 
characteristics both of revenue and of protective measures. 



Cii. IG] THE POLICY OF A PROTECTIVE TARIFF 249 

A tariff that reduces imports but does uot cut them off en- 
tirely may be called either a revenue tariff with incidental 
protection or a protective tariff with incidental revenue. The 
difference is one of degree. But notice particularly that the 
two features of protection and of revenue are mutually exclu- 
sive. To the extent that one is present the other is impos- 
sible. A tariff rate that in whole or in part excludes the for- 
eign article to that extent affords "protection" but does not 
yield revenue. Whenever the government collects a cent of 
tariff taxes, the domestic producer in so far and as respects 
that unit of goods is "unprotected." Likewise, whenever 
a tariff gives to the domestic producer "protection" in re- 
spect to any unit of goods, it does so by prohibiting the 
importation of the goods, and the government is deprived 
of any revenue whatever derived from the importation and 
sale of that unit of goods. In short "protection," just in so 
far as it "protects," is prohibition of imports. Non-impor- 
tation and revenufe are mutually contradictory. 

§ 3. Growth of a protective system. The protective pol- 
icy developed at first accidentally, as it were, out of the prac- 
tice of levying taxes for revenue only. Tolls, dues (or du- 
ties), customs (that is, in former times the customary dues 
paid by merchants, now the dues fixed by law), tariffs (that 
is, schedules or lists of rates of duties) were at first intended 
to raise revenues for the sovereign, the city, or the state. The 
unintended, and to some degree inevitable, result of the tax- 
ation of goods in commerce, whether imports or exports, is to 
prevent and discourage trade and to raise the prices of the 
goods imported. Any change in tariff duties, therefore, at 
once alters the previously existing adjustment of profits and 
of industries in a country. 

The first effect of the tariff* is the same as that of any 
new factor in enterpriser's cost; the same, for example, as 
that of a new domestic tax on an article or as that of a rise 
of freight rates — the domestic price of the taxed article tends 
to rise. Other results then follow. If the article cannot, 



250 TARIFF AND TAXATION [Pt. Ill 

even at the higher price, be produced within the country (as 
in the cases of oranges, spices, and coffee in England, Norway, 
and Sweden), its consumption is reduced. The lessening of 
demand may, however, depress somewhat the price in the pro- 
ducing country. But as such a tariff does not increase home 
production of the taxed article, it is therefore for revenue, 
not for protection. 

But if the article can be profitably- produced in the import- 
ing country at the new price, "home industries" will start. 
Where the transportation charges are low, as on the coasts 
and on the main lines of railways, some imported goods may 
be bought, while farther inland, where transportation charges 
are higher, home production of some or all grades of such 
goods may take place. If the whole demand at home is sup- 
plied and all imports stop, therewith cease all revenues to 
the government from that source. A completely protective 
tariff is completely prohibitive. 

Experience abundantly shows that, with a few exceptions, 
due to climate and natural resources, it is impossible to put 
into effect the most moderate schedule of duties without the 
increase in price at once causing some men to shift their 
occupations, and to begin producing articles of the kinds 
that have risen in price. At once appears a group of "pro- 
tected industries," the owners of which are dependent for 
the safety and profits of their investments, and workmen in 
which are dependent for the security of their present jobs 
(possibly for the chance to continue the pursuit of highly 
skilled trades), on the continuance, if not the increase, of 
the existing tariff rates. A tariff may be adopted mainly 
from stress of financial need (as in our own history in 1789 
or in 1861), but its modification or repeal cannot be decided 
by fiscal considerations. The "incidental protection" it 
affords has created a wealthy and influential group of em- 
ployers and a large body of employees who are irresistibly 
tempted to exercise their influence in politics almost solely 
in favor of continuing and of increasing the rates to the sacri- 



Cir. 16] THE POLICY OF A PROTECTIVE TARIFF 261 

fice of the higher civic life of their communities. Of course, 
the beneficiaries of the tariff usually believe sincerely that it 
is indispensable for the prosperity of the country as a whole, 
and they can do much to persuade others to the same opinion. 
This commercial motive for maintaining existing protective 
tariffs explains in large part their wide prevalence, whatever 
other reasons may be adduced in their justification. 

§ 4. The infant-industry argument. Most free-trade 
writers concede a limited validity to the claim that protection 
may be used to encourage infant industries and thus diversify 
the industries of the country. If the natural resources of 
a land are adapted to an industry, it may be called into be- 
ing earlier by a fostering protective tariff. This is merely 
anticipating and hastening the natural order of progress. 
In the American colonies the manufactures of such goods 
as iron, cloth, hats, ships, and furniture sprang up and con- 
tinued not only without ''protection," but despite numerous 
harassing trade restrictions made in the interest of English 
merchants. Can it be doubted that many of these industries 
would have developed and flourished after the. adoption of 
the Constitution with no other favoring influences than those 
of rich resources and of economy in freights? In the Mis- 
sissippi Valley since 1880 natural gas, abundant coal, ore, 
and timber have made possible a great growth of industries 
without protection against the eastern states. Industries ca- 
pable of eventual self-support must in most cases naturally 
appear in due time. Economic forces will bring them out. 
Protection of infant industries may be likened to a hothouse, 
anticipating the season by a few weeks and at great cost. 
The question is whether the mere possession of the hothouse 
is a luxury worth the price, if meantime the products can 
be got more cheaply by trade. English manufacturers 
flourished in the nineteenth century because they were well 
established, had excellent coal supplies, good stores of iron 
ore, and low-paid labor which did not have the opportunity 
of better alternatives, as did the American workman. If 



252 TARIFF AND TAXATION [Pt. Ill 

America had imported more (it would not have been all) of 
her iron and coal, the English mines would have begun to 
shown signs of exhaustion earlier, and America's advantage 
surely would have asserted itself in time. Her iron manu- 
factures undoubtedly were hastened — ^they cannot truly be 
said to have been created — by the protective tariff. 

The peculiar advantages of a new country attract labor 
and enterprise into a few lines. Industries are forced into 
an earlier diversification by tariffs. "Which is the better eco- 
nomic situation? Contrast the life of the workers in Iowa, 
the Dakotas, and Minnesota, or Kansas, if you please, with 
that in crowded tenements of New York and in the mining 
regions of Pennsylvania. Is it so certain that a dense popu- 
lation congested in cities and crowded in factories and mines 
is a more ideal social aggregation than is a community of 
prosperous farmers? The smoky industrialism fostered by 
protection often puts a premium on a low grade of immi- 
grants, crowds them into city slums and into forlorn mill 
toAvns, and keeps them aliens to the American spirit. It 
would be surprising if Americanism on the western plains 
were not as sound as in the crowded cities. But the infant- 
industry argument appeals strongly to the enterprise and 
the speculative spirit of Americans, who like to do all things 
rapidly and on a large scale. Every village aspires to be 
a great industrial center. Americans are impatient of the 
suggestion that things ' ' will come in time ' ' ; they like things 
to coijie at once. 

It must, however, be recognized that in a new country there 
is often a certain monotony and poverty of life because of 
the lack of diversified industries. There are not sufficiently 
varied avenues for the expression and use of the manifold 
talents of the nation. There are unused materials and op- 
portunities; but the initial expense of experimentation, the 
initial difficulties of gathering and training a working force, 
are discouraging to individual enterprise, prices being as 
they are. A protective tariff is not necessarily and always 



Cir. IG] THE POLICY OF A PROTECTIVE TARIFF 233 

the best way, but it is one way of helping private enterprise 
to establish and conduct such industries through their initial 
period. But, as has been pointed out by many writers, the 
infant-industrv' argument is self-limiting, and involves always 
the assumption that the industries selected as fit for protec- 
tion are such as ultimately, and within a moderately short 
period, can grow into self-dependence. The infant must 
sometime grow to be a man and stand on his own legs, or he 
is either a chronic invalid or a degenerate. 

§ 5. The home-market argument. The home-market argu- 
ment seeks to show a more permanent need for a tariff. At 
the same time it appeals to the farmers, whom it has been 
hard to reconcile to a policy that in America - has been 
peculiarly favorable to manufacturers. The home-market 
argument extols the advantages of having near to the farms 
customers for agricultural products, and dwells on the greater 
steadiness of domestic trade. War or political changes, it is 
said, may change the demand for products. This is true, but 
no other changes have affected American agriculture so radi- 
cally as the peaceful development of domestic transportation 
and the opening of the "West. 

The main economic claim made in the home-market argu- 
ment is that the shipping of food to Europe and the import- 
ing of manufactures involve a great cost for double freights 
that could be saved by manufacturing at home. The farmer 
is supposed to pay this cost. The obvious defects in this view 
are: first, there is nothing to show that the freight is not 
partly or entirely paid by the European, either the manu- 
facturer or the food consumer; secondly, home trade "saves 
tlie freights" for the farmer only in case he can buy goods 
under a tariff with less of his own labor and products than 
under free trade. The payment of freight charges is true 

- In European countries, on the contrary, the rates that have been 
mainly effective have been those levied upon food products, and the 
agricultural landholders have been the "protected interests," such as the 
England "landed aristocracy," the German agrarian '"Junkers," and 
the French peasant landowners. 



254 • TARIFF AND TAXATION [Pt. Ill 

economy wlien the goods can be bought at a distance on more 
favorable terms than near home. The freight argument at- 
tempts to prove too much, for it condemns every trade within 
the country of goods produced a stone's throw away from the 
consumer. 

The home-market appeal is strongest when addressed not to 
all farmers, but to one class of farmers — those whose lands 
are situated nearer the manufacturing cities. As city popu- 
lation grows, some land is converted from the extensive cul- 
tivation of corn and wheat to dairying, fruit- and market- 
gardening in the neighborhood of cities, and perhaps at 
length is used for factory sites or as city lots. There is, thus, 
a partial validity in the argument as applied to a compara- 
tively small number of farmers, who gain as landlords, not 
as tillers of the soil. Even greater gains have sometimes 
been reaped by the owners of timber-lands, ore-mines, coal- 
lands, and other natural resources, the values of which have 
been raised by tariff legislation. But, unless these gains 
come from truly productive additions due to the tariff, there 
is no benefit to the community as a whole. 

§6. The "two-profits" argument. Somewhat related to 
this idea of the home-market and the saving of two freights 
is the "two-profits" argument. It is said that the tariff keeps 
"two profits" at home; foreign trade gives but one. The 
word "profits" is here used in the popular sense of gain 
from a single transaction. Both parties are said to profit, 
and both profits are thought to be secured at home when two 
citizens are forced to trade with each other. The view that 
there are "two profits" in a trade is an advance upon the 
notion that "one man's gain is another's loss,"^ but there 
is an error in elementary arithmetic here, both as to the num- 
ber and as to the aggregate amount of profits. The pur- 
pose of a protective tariff is to compel two citizens of a 
country to trade with each other instead of trading with two 
citizens of a foreign state ; the number of profits made by each 

3 See cli. 15, § 1. 



Ch. 16] THE POLICY OF A PROTECTIVE TARIFF 255 

country is therefore not increased by substituting domestic 
for foreign trade. 

What, then, as to individual size and aggregate amount 
of the profits? The gain is not the same in all trades; the 
trade is made if there is a gain to each party, no matter how 
small it is; but the generous ''profit" on one transaction 
where the conditions of the two parties are very different may 
be greater than the total of petty gains on a dozen trades 
between two traders of evenly matched powers. Indeed, the 
greater the difference in the conditions and capacities of two 
groups of traders, the greater is the sum of the profits that 
they may secure through the members of each group trad- 
ing with those of the other, rather than by the members of 
each group trading only among themselves. Can it safely 
be assumed that every trade with a foreigner is less advan- 
tageous than one with a fellow citizen? Diamond cuts 
diamond, but two Yankees left to themselves should not be 
worsted in bargains with the universe. If they could ex- 
change to better advantage with each other, they probably 
would discover it as soon as the interested manufacturers and 
political orators who can prove so eloquently that they know 
the other man's business better than he knows it himself. 
Forcing the home trade by making our citizens trade with 
each other, whether both wish or not, may be to the advan- 
tage of one citizen, but it is not likely to be to the advantage 
of both citizens. 

§ 7. The balance-of-trade argument. At the foundation 
of nearly all belief in the virtues of a protective tariff will 
be found the "favorable balance-of-trade" notion. The ideal 
of the more thoroughgoing upholder of a protective policy 
is to keep merchandise consistently flowing out of the coun- 
try, and to have nothing coming in — in any case, nothing 
that by any fair amount of effort (whatever that be) could 
be produced at home. This is called maintaining a "favor- 
able balance of trade." Sometimes the emphasis is more on 
the advantages of an excess of exports of goods, sometimes 



256 TARIFF AND TAXATION [Pt. Ill 

more on the importance of the need ' ' to keep money at home. ' ' 
The simple error in these opinions is clearly apparent in 
the explanation of foreign exchanges and of the principles 
regulating the international flow of money.* 

An interesting commentary on the opinion before us is the 
fact, already noted,^ that an excess of exports is the usual 
situation in poor debtor countries having constant interest 
payments to meet ; while, on the contrary, rich creditor coun- 
tries have an excess of merchandise imports. 

The "favorable balance-of -trade" argument, with the em- 
phasis on money rather than on goods, is that the protective 
tariff keeps money at home which, if trade is free, will be 
sent abroad to buy foreign goods, thus impoverishing the 
country. This doctrine, as presented in the seventeenth and 
eighteenth centuries in Europe, was known as mercantilism. 
It had great influence upon the commercial policies of all 
the great European nations. A superficial glance at the 
trade relations of an old rich country with a new province 
seems to give evidence for such a belief. A richer country 
that ^ is lending capital (sent to the debtor country in the 
form of goods) has at the same time a larger supply of 
money. The lack of money and the poverty of the newer 
country are looked upon by the protectionist as due to the 
importation of goods. The common cause of the imports to 
newly settled districts and of their scanty stocks of money, 
it need hardly be repeated here, is the comparative poverty 
of ^settlers and pioneers.^ Often these are paying for im- 
ports by means of loans, and in any case their monetary 
stocks are not decreased either by their foreign trade or by 
their domestic trade with the older and richer parts of the 
same country. Europe and the United States, in their trade 
with China and South America, usually do not get gold in 
exchange, but merchandise of various sorts. It is true that 

4 See ch. 3, § 7 and ch. 15, §§ 7-11. 
sin ch. 15, § 8. 
6 See ch. 2, § 8. 



Ch. 16] THE POLICY OF A PPxOTECTIVE TARIFF 257 

in the trade of England and New York with great gold-pro- 
ducing districts, such as California, South Africa, and 
Alaska, gold is received in return for merchandise, for much 
of the gold in gold-producing districts is merely merchandise, 
and its export does not drain them of their due portion of 
money. There was a time when the states of Kansas, Ne- 
braska, Iowa, and their neighbors were filled with resentment 
against the money-lenders of the eastern states. There was 
a widespread belief that hard times were due to an insuffi- 
cient currency.' Attempted action tdok the form of the green- 
back and free-silver movements, which were defeated by the 
opposition of the East; but there can be little doubt that if 
the Federal Constitution had not forbidden it, the discon- 
tented states would have established a protective tariff "to 
keep their money at home." Few advocates of protective 
tariffs are ready to admit that the monetary stock of the 
country is dependent on the general wealth of the country 
and on the methods of doing business, rather than on a pro- 
tective tariff, 

§ 8. The claim that protection raises wages. The most 
effective popular claim made for protection is that it raises, 
or maintains, the general scale of wages in the country. This 
argument takes two forms : first, when wages are low in a 
country it is claimed that a tariff is needed to raise them ; and, 
secondly, when wages are high it is argued that a tariff alone 
can preserve them. In Germany the fear was of the higher 
paid and more ef^cient labor of England. In America, where 
general wages at all times have been higher than in England, 
it was first argued (in the time of Henry Clay) that because 
of the greater cost of production, due to high wages, the tariff 

7 That there is a certain measure of truth in this opinion is recognized 
in our discussion of the standard of deferred payments, eh. 5, § 9. 
But the relation of a world-wide appreciation of the standard money 
commodity with the burden that this change puts upon debtors has 
nothing to do with the question now before us, viz.: Does a protective 
tariff enable a country to keep and increase its proportion of the world's 
stock of gold; and if it could, would it be a general benefit? 



258 TAEIFF AND TAXATION [Pt. Ill 

was needed to start certain industries ; but after the tariff had 
long been established and the old argument had been for- 
gotten (even since 1865), it has been urged that the tariff is 
the cause of high wages, and must be maintained to protect 
against the "pauper" labor of the older countries. The 
higher wages in new countries where a tariff exists are always 
claimed to be the fruits of a protective policy. 

The true cause of the high general scale of wages in America 
is the greater efficiency of industry under existing conditions.^ 
Labor is surrounded here with advantages in the forms of 
rich natural resources and of mechanical appliances such as 
never before were combined. Because of the scarcity of 
workers in particular protected industries, wages may be tem- 
porarily higher in them than in some other industries; but 
such workers form a small fraction of the population, and it 
is impossible to show that the general scale of wages in all 
occupations is raised by the tariff protecting this fraction. 

There is, of course, no question that every tariff change af- 
fects certain enterprises and classes of workmen. Enter- 
prisers already acquainted with and engaged in a business 
always may hope to gain by the higher prices immediately 
following a rise in the tariff rates on their particular products. 
Though they are granted no enduring monopoly by the pro- 
tection, they for a time enjoy the advantage of being on the 
ground, and may reap the first fruits of the favoring condi- 
tions. The enterpriser usually profits when the price of his 
product suddenly rises. Usually skilled workmen are af- 
fected slowly by competition when there is any considerable 
increase of prices in their special industries. The important 
question is. Who bears the burden of the higher prices that 
result from a tariff? The burden is very soon distributed. 
A part of it may be for a short time borne by the retail mer- 
chants, but ultimately nearly the whole of it must be borne 
by their customers, the unfortunate, less favored citizens. 
The weight falling on each is usually small, often unsuspected, 

8 See Vol. I, especially p. 228, and chs. 34 and 36. 



Ch. 16] THE POLICY OF A PROTECTIVE TARIFF 259 

always hard to measure. The increased benefit is concen- 
trated in a few industries and accrues to a comparatively few 
producers. Here is a recipe for riches : get everybody to give 
you a penny; it's so little that no one will miss it, and it will 
mean a great deal to you. Something like this happens in 
the case of many protected industries ; every consumer of the 
article pays a few cents more, a small group of wage-earners 
temporarily gains, and a few enterprisers wax wealthy. 

§ 9. Tariffs and unemployment. The claim that a low 
tariff is bad for the workers is made with peculiar success in 
any period when unemployment is greater than usual. It 
is usually unconvincing to reply that again and again equally 
bad periods of unemployment have occurred when a high 
tariff was in force, and that often the most highly protected 
industries are most affected. It is unconvincing to suggest 
that fluctuations of unemployment are related rather to the 
rhythm of industrial cycles and panics, than to any partic- 
ular level of the tariff, whatever it be.^ The fact that at 
the moment is seen is that here are some men for the time out 
of w^ork, and here are some foreign goods coming in. Of 
course, what is not seen is that if we stop importing goods we 
thereby eventually will stop the exportation of goods of equal 
value now being sent in payment, and this must throV as many 
men out of jobs as we helped into jobs by raising the tariff. 
But the view easy to take is the short view, and the ulterior 
consequences seem to the popular mind to be vain imaginings. 

An explanation of periodic unemployment involving the 
same error in a smaller degree is to attribute it to immi- 
gration. It is true that after a crisis has occurred, and 
during the period of widespread unemployment, limitation or 
prohibition of immigration may prevent aggravating the evil 
at the time. But immigration as a continuing policy is not 
the cause of periodic unemployment, but its bad effects will 
rather be shown in the permanent lowering of the general 

9 See on wages in times of crises, ch. 10, § 6 and § 7 ; and on tariff 
changes, ch. 10, § 11 and § 13 below. 



260 TARIFF AND TAXATION [Pt. Ill 

level of wages. ^° But, whatever be the general level of wages, 
periods of iinemployment will recur as long as means have 
not been found to control marked credit and price fluctua- 
tions within the business cycle. 

§ 10. Exports and exhaustion of the soil. It has been in- 
geniously argued that a tariff may keep some of the natural 
agricultural resources of a new country from becoming 
quickly exhausted. The export of food takes out of the soil 
and out of the country fertile qualities never to be returned. 
The shipment of several hundred million dollars worth of food 
products year after year represented a tremendous drain from 
the soil of the United States, but this has now largely ceased. 
The assumption, however, that the use of the food in this 
country preserves the fertility of our own fields is in the main 
mistaken. The fertile material in the food for human con- 
sumption hauled to a town five miles away from the field is 
almost as entirely lost as if it were shipped to Europe, En- 
gineering skill has as yet succeeded in returning economically 
to the fields from which it comes hardly a fraction as much 
fertile organic matter as that which flows into the sewers, that 
is dumped into river and ocean, and that is buried in heaps 
at the borders of our awn cities. Artificial fertilizers are 
increasing'ly used, to be sure, but they are obtained in other 
ways. On the other hand, the increased use of iron, coal, and 
timber, as a result of encouraging manufacturers, has very 
effectually hastened the exhaustion of the natural resources 
of- the country. 

§ 11. Protection as a monoply measure. It has rightly 
been observed that a new country has a limited potential 
monopoly in certain kinds of products and that a tariff may 
make it effective. The rapid opening up of America 
with its rich natural resources greatly benefited the average 
consumer in western Europe, although it caused a loss to a 
special class of landowners." Whether the citizens of the 

10 See ch. 25. 

11 See Vol. I, pp. 361 and 443. 



Ch. 16] THE POLICY OF A PROTECTIVE TARIFF 261 

older or of the newer country shall reap the greater benefit in 
the trade depends on the reciprocal demand for the two 
classes of goods, as was seen in discussing the equation of in- 
ternational demand. A wide margin of advantage may go to 
one party and a narrow margin to the citizen of the more fa- 
vored land. To put it concretely : America, having great 
natural resources for agriculture, might continue to trade 
food for manufactured goods even though England reaped 
most of the benefits of the trade. An American tariff on 
manufactures from England would, under such conditions, 
check the demand for English products and compel some 
Americans to leave farming. This reduction of the Amer- 
ican supply of wheat or corn and of the American demand 
for English manufactures compels a new ratio of trade (ex- 
pressed in prices). It is conceivable that trading fewer 
goods with a larger gain on each trade would give a larger 
total of gain to the favored nation. Thus, foreigners may 
conceivably be compelled to pay a part of the tariff duties to 
enjoy the favored market. This is but a special case of the 
monopoly principle ; the government by law artificially limits 
the supply of goods offered by its citizens. 

This argument is somewhat subtle, but probably is the 
soundest one in the theory of protection. The supposed con- 
ditions seldom occur in a marked measure, but they may 
exist, and probably have existed in America. When the great 
sj^stem of internal transportation was developed in the United 
States before that of the other new countries (say from 1840 
to 1894), this country had such peculiar advantages for the 
production of food that the quantity was enormously in- 
creased and agricultural prices fell.^^ At such a time the tariff 
may have worked toward checking the fall and earlier reestab- 
lishing a more favorable ratio. It did this by making prices 
of manufactured goods in this country artificially higher and 
thus tempting men from rural to urban callings. But the 

12 See Vol. I, p. 436, for average wheat prices in England, practically 
in the world-market. 



262 TARIFF AND TAXATION [Pt. Ill 

limited application of the principle must be recognized. The 
potential competition of undeveloped countries on all sides, 
seeking to develop their resources, and profiting by the higher 
prices of food in the world-market caused by our tariff, 
threatens the peculiar advantages of the favored land, Rus- 
sia, Argentine, and Australia have rapidly taken the place of 
America in supplying food to western Europe, in part, no 
doubt, because we refused to take Europe's goods in trade. 
A great nation with its manifold interests is not eminently 
fitted to practise the gentle art of monopoly. 

The period in America from about 1840 to 1890 shows cer- 
tain absurd contradictions in economic policy. By govern^ 
mental action, national, state, and municipal, enormous 
grants of money and lands were made in aid of transportation. 
Canals, roads, and railways were built into new agricultural 
territory far faster than was healthy and normal. A prodigal 
land policy put a premium upon a wastefuUy rapid exten- 
sion of the farming area. These things were done to favor 
the agricultural states; but agricultural prices fell so greatly 
that our farmers for a long period were nowhere prosperous, 
and great numbers of them, both in the East and in the West, 
were ruined. At the same time a high tariff on nearly every- 
thing the farmers needed to buy was the political spoil ob- 
tained by the eastern and middle states. This further de- 
pressed the condition of the farmers and forced them or their 
sons into urban industries. A slower development would 
have occurred without the waste of national resources in such 
conflicting policies of artificial stimulation. 

§12. Equalizing "costs of production." An idea ad- 
vanced incessantly by American advocates of a protective 
tariff is that the tariff on every article imported ought always 
be high enough to equal the difference between the higher 
costs here and the lower costs abroad. The equalizing-cost 
rule was laid down in different words by each of the two 
leading political parties in the campaign of 1912. The 
Republican platform set forth what it called the "true prin- 



Ch. 16] THE POLICY OF A PROTECTIVE TARIFF 2G3 

ciple."^^ The fallacy of this rule appears, however, in the 
study of the confusion connected with the idea of monetary 
costs.^* 

"Costs of production" in the "time principle" means the 
monetary costs of the enterpriser. Now a first difficulty 
is that costs are not uniform for all establishments in any 
one industry, and a tariff high enough to protect some is 
entirely too low to protect others. As long as a tariff rate 
is too low to exclude every unit of the foreign product, 
its importation is conclusive proof that for some home pro- 
ducers the tariff rates fall short of the "true principle" 
(better proof, indeed, than the most elaborate investigation 
by any tariff board could be). The indubitable truth is that 
no trade ever can take place (in a monetary regime) unless 
the monetarj' price is lower in the exporting than it is in the 
importing country. This virtually means that the product 
cannot be profitably exported unless the monetary costs of 
production ("together with a fair profit") of the article ex- 
ported are for each party less than those of the other party 
in the other country. The so-called "true principle" would 
lead thus to absoluteh' prohibiting the importation of every 
article to which it was applied. 

In the enactment of the Underwood tariff, the Democratic 
party, traditionally committed to a tariff for revenue, ap- 
plied what was called the "competitive principle." This 
"competitive principle" is essentially the same as the Repub- 
lican so-called "true principle" of equalizing the cost of 
production. It is a prohibitive, not a free-trade, principle. 
Strictly applied, it would cause complete exclusion of imports. 
But, as applied to selected articles which it is desired to ex- 
clude in order to "protect" the domestic producer, this princi- 
ple would simply prevent the rate being placed appreciably 
higher than was needed to exclude them. Anything beyond 
that point but offers temptation and opportunity for the for- 

13 See ch. 14. §12 

14 See ch. 15, § 5 and § 6. 



264 TARIFF AND TAXATION [Pt. Ill 

mation of a monopoly by domestic producers. Then, too, the 
rate may intentionally be fixed so as to make just possible the 
survival of the most favorably located or most efficiently oper- 
ated establishments, while compelling the abandonment of 
other establishments. 

It will be seen that the rule of equalizing the cost of 
production is really not an additional argument for pro- 
tection, but rather is a rule for fixing the proper rate, on 
the assumption that "protection" is desirable on grounds 
of any or all of the staple arguments offered in its support. 
Just how high ought and must the rate on a particular 
article be to start an infant industry, to preserve the home 
market for any group of producers, to retain both profits, 
to give a "favorable balance of trade," to raise wages, and 
to prevent unemployment? The answer given by the rule 
is : high enough to prohibit the importation of goods. Either 
the rule of equalizing monetary costs, or the competitive 
principle, if strictly applied in favor of all producers, would 
prohibit all imports. If applied in varying measure in favor 
of the more favorably situated producers (as regards loca- 
tion, transportation, natural resources, skill, capital, etc.), 
the rule would protect some and eliminate other home pro- 
ducers. Here again is seen the truth that protection, if it 
protects, is prohibition of imports. 

§ 13. Tariff legislation and business depressions. The re- 
lation between new tariff legislation and the business condi- 
tions following it has been the subject of much debate in 
political campaigns. In the few cases where a relationship 
has been most often asserted to exist, it is more probable that 
the tariff change was the result of business conditions pre- 
ceding it than that it was the cause of the conditions follow- 
ing it. For usually a tariff has been revised downward be- 
cause a few years of prosperity with large imports had so 
increased customs duties that the government has had sur- 
plus revenues. Just when the tariff was reduced, the condi- 
tions were ripe for a crisis. This happened in 1857 (already 



Cir. IG] THE POLICY OF A PROTECTIVE TARIFF 265 

in 1856 there had been a preliminary halt of business), again 
in 1872, and on a small scale in 1883. But the main reduc- 
tion resulting from the compromise act of 1833 did not occur 
until after tlie crisis of 1837-39; the Walker Act of 1846 
was passed just as business was starting upward on a long 
wave of prosperity; and the act of 1894 was passed a full 
year after the severe crisis of 1893, when business had already 
entered upon a period of depression. In none of these cases 
does it seem reasonable to attribute business depression to 
the reduction of the tariff, as is commonly done in protec- 
tionist arguments even to the point of attributing the panic 
of 1893 to the reduction of the tariff a year later! 

At several times the tariff has been raised soon after a crisis 
when a good occasion was presented by the need of larger 
revenues, as in 1842, 1860, 1875, and 1897. Business at such 
times is just at the point of the cycle when prosperity is 
due. The higher tariff of 1842 was succeeded by the low tariff 
of 1846 without any check to business. The war obscured 
the ordinary industrial effects of the tariff acts of the sixties. 
The increase in the year 1875 was followed by four years of 
hard times and slow recoverj^ The increase of the tariff in 
1890 occurred as business was nearing the top of the cycle, 
and was followed by two years of prosperity, culminating in 
the very severe crisis of 1893. The authors of the tariff of 
1897 were peculiarly fortunate in the time of their action, 
for the country was just fairly recovering from the very 
severe crisis of 1893, and prosperity was to continue (with 
brief hesitation in 1900 and 1903) mitil the severe crisis and 
panic of 1907. 

The advocates of higher rates are, of course, correct in 
declaring that the great business prosperity of the years 
1915 and 1916 resulted from the unexpected demands in 
foreign trade growing out of the war, and is not to be 
credited in large measure to the act of 1913. But reason 
requires that the same restraint be exercised in crediting to 
higher protective acts the prosperity that has in some — not 



266 TARIFF AND TAXATION [Ft. Ill 

all—cases followed their enactment; and requires further 
that the act of 1913 be not held accountable for the reaction 
of trade in 1920, inasmuch as a reaction was sure to occur 
soon after the war ended no matter what kind of tariff act we 
might chance to have at the time. 

§ 14. Harm of sudden tariff reductions. It is rarely ap- 
preciated how great is the tactical advantage which the advo- 
cates of a high tariff enjoy in popular political discussion. 
They can so easily impress the popular judgment with the 
evident fruits of their own policy and with the immediate 
dangers of the policy of their opponents. When a protective 
rate is first applied or is increased, it calls into existence 
something visible and tangible, which can be measured in 
terms of factories built, men employed, and products turned 
out. The increased cost of these results is diffused among 
many consumers and reaches them in such indirect ways and 
in such small increments of price that they are quite un- 
aware of the way they are affected. ^^ 

. On the other hand, reduction of the tariff works in a direc- 
tion the reverse of its enactment. It may cause local crises 
and may even bring on a general crisis. The benefits of the 
lower prices are diffused and lost to view ; the immediate in- 
jury is concentrated and strikingly evident. Factories are 
closed, investments depreciate, laborers are thrown out of em- 
ployment. The organic nature of local industry causes these 
evils to be felt by many classes. Merchants, professional men, 
servants, and skilled laborers, that are tributary to the de- 
pressed industry, suffer. The effects are transmitted to com- 
mercial and financial centers and often credit is much shaken. 
Then follows a slow and painful process of readjustment. 

The low-tariff advocates in America undoubtedly have un- 
derestimated these immediate effects. They have been too ab- 
stractly doctrinaire, have argued too absolutely for the merits 
of free trade, to be applied instantly regardless of the exist- 
ing distribution of investments and of occupations. They 

15 See § 8. On the next paragraph, see ch. 10, § 11. 



Ch. 16] THE POLICY OF A PROTECTIVE TARIFF 267 

have opposed one extreme system by another, with no thought 
of the inexpediency and injustice of sweeping changes. There 
is a strong feeling among business men that any tariff, be it 
high or low, is better than a shifting policy. Despite the 
great preponderance of domestic production over foreign 
trade, it is perhaps too much to say that the tariff is unim- 
portant in our present conditions. It can, however, be truly 
said that business can adjust itself in large measure to any 
settled conditions, and that radical changes, especially sudden 
and large reductions, are fraught with evils. Long before a 
new tariff law goes into effect, even months in advance of its 
passage, while it is merely in prospect, the course of trade is 
abnormally affected. If the rate is likely to be raised, large 
importations take place under the lower rate, and for a con- 
siderable time after the law goes into effect imports are small, 
while prices rise and domestic production gradually increases. 
But if the rate is likely to fall, importations are for months 
meager, stocks of goods are reduced to the lowest point, and 
when the lower rate goes into effect, large importations follow 
to the injury of domestic producers. In many cases a year 
or two of notice, time given to enterprisers to adjust their 
business, Avould probably do away with a large part both of 
the serious losses and of the lottery-like gains that other- 
wise occur. 

The obvious measure of precaution and of justice would be 
to put any new rate into effect gradually .^^ The difficulties 
are of a political nature and in the desire of the party in 
power to "make a showing" at once of the results of its cam- 
is For example, the maximum alteration m any year might be limited 
to 3.65 per cent of the value of the goods and in any case not to exceed 
one tenth of the old duty, this change to be applied day by day. Thus, 
if, on a valuation of $1000, the duty collected under the old rate has 
been $400 and under the new law is to be $290.50, three years would 
be required for the full change to become effective, the reduction each 
day being $.10 per $1000 valuation. The administration of such a rule 
would be simple, and it has been favored by men of practical commer- 
cial experience. 



268 TARIFF AND TAXATION [Ft. Ill 

paign pledges, in the one case by starting and stimulating in- 
dustries through a higher tariff and in the other by reducing 
prices to consumers through a lower tariff. Under the new 
permanent tariff board, constituted to suggest tariff changes 
and to administer the tariff laws, it would be possible to apply 
some such feature. 

§ 15. Some lessons from our tariff history. From the 
checkered 'course of tariff history in America it is difficult to 
draw clear lessons of wisdom for the future ; but at least 
certain negative conclusions may be safely drawn. It is a 
history of a vacillating public opinion toward the policy of 
protective duties. Always the policy has kept some hold on 
public sentiment, but it has varied in strength, now waxing, 
now waning. The time of revisions has been determined 
nearly always by varying needs of revenue. When more in- 
come has had to be raised, this has nearly always been made 
the occasion and pretext for increasing the degree of pro- 
tection for many industries. This is not at all a necessary 
connection, for it would be possible to couple internal revenue 
taxes and customs duties in such a way that the rates would 
go up and down together and give the varying amounts of 
revenue required for the government without appreciably 
altering the relative profitableness of various private enter- 
prises. Now that customs duties are no longer the chief 
source of revenues for the federal government, and are out- 
weighed many times in fiscal importance by income taxes 
and internal revenues, the question of fostering favored in- 
dustries should be more easily kept distinct from that of 
raising public revenues. 

Our tariff history is too largely a record of special favors 
granted to classes of citizens, to citizens of certain locali- 
ties, and to particular enterprises. This is apparent even in 
a general survey, but almost every more detailed examination 
.of particular protective rates reveals evidence of suspicious 
and sometimes scandalous personal influences at work. The 
protective policy has always professedly been advocated for 



Cir. IG] THE POLICY OF A PROTECTIVE TARIFF 269 

the general welfare, to raise wages or to make the country 
prosperous; but the initiative has always been taken, and the 
valiant work in contributing funds for campaign purposes 
and in lobbying bills through Congress has been done, by 
the interested manufacturers. Even if it were beyond ques- 
tion sound in principle to exclude goods that can be bought 
more cheaply by trade, it is very doubtful whether any net 
good could have resulted from this policy as it has been in 
fact applied and followed. The frequent and unpredictable 
changes have been a great evil, and have again and again 
brought unmerited losses to the many in business and still 
greater and unearned gains to a favored few. It is incredible 
that such a hit-or-miss, in large part selfishly determined, 
policy could have been an important cause of our national 
prosperity. The fundamental causes of the general high 
wages and popular welfare that we have enjoyed is to be found 
rather in our rich natural resources, our capacity for self- 
government with free institutions, and the industrial energies 
of our people.^'^ 

17 See Vol. I, e. g., pp. 228, 431, 445ff, 466, 490, 506ff. 

References. 

Whitaker, A. C, Foreign exchange. New York. Appleton. 1919. 
Daniels, W. M., The elements of public finance. Pt. II, ch. VII. 

N. Y. Holt. 1904. 
Johnson, E. H., The effect of a tariff on production. Q. J. E., 18: 

135-137. 1903-1904. 
Patten, S. N., The economic basis of protection. Phil. Lippincott. 

1890. 
Wallace, H. B., A balanced tariff. A. E. Rev., 2: 568-575. 1912. 



CHAPTER 17 



OBJECT'S AND PRINCIPLES OF TAXATION 

§ 1. Public finance as a division of economics. § 2. The police func- 
tion. § 3. Social and industrial functions. § 4. The enlarging sphere 
of the state. § 5. Industrial revenues of governments. § 6. Govern- 
mental receipts from loans. § 7. Non-revenue character of receipts 
from loans. § 8. Revenues from taxation. § 9. Kinds of taxes. §10. 
Defective tax "systems." § 11. Various standards of justice suggested. 
§ 12. Social vs^elfare as the aim. § 13. Principles of administration. 
§ 14. Shifting and incidence. § 15. Taxes as costs. § 16. Taxation 
and socialism. 

§ 1. Public finance as a division of economics. Men live 
together in politically organized societies which employ public 
officials as agents to carry on the functions of government. 
Every governmental unit, large or small, may be viewed not 
only as a political body, but as an economic enterprise. Each 
has its economic aspects, such as receipts and expenditures, 
employer and employee, borrowing and lending, etc. Each 
political unit is in this sense an "economy." The study of 
the public economy, of the economic aspects of government as 
distinguished from its political aspects, constitutes the science 
of public finance, an important division, though not the whole, 
of political economy. 

The primary fact determining the public finances is the 
extent of the sphere of "the state," meaning by the state the 
totality of political powers and functions in a community. 
There are two typical ideals of a state, each with correspond- 
ing functions: the ideal of the police state, and that of the 
social-industrial state. In fact, every system of government 
provides for the exercise of both functions in some measure. 
The police function is primary. All governments alike exer- 

270 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 



271 



cise it, but they differ most in respect to the degree in which 
they exercise the social-industrial functions. 

§ 2. The police function. The police function is that of 
public defense and the maintenance of domestic order. In 
family or patriarchal communities all share a common income 
and combine in the common defense; but self-preservation 
often has compelled such small communities to form a large, 
stronger state for the common defense. Public defense re- 
quires sacrifice of some independence on the part of the family 
and of the individual. Personal service in the field gives place 
later, in some measure, to the payment of taxes, so that a regu- 
lar income may permit the government to attain a more 
regular, continuing, and perfect organization of military 
forces. 



GROUP I 

RECENT AND PREVIOUS WARS 

$3,855,482,536 67.8 PER CENT 



GROUP II 

ARMY AND NAVY 

$1,424,138,677 25.0 PER CENT 



primut doie>iimeiit<l fukctiois 



PUBLIC wonts 



Fig. 1, Chapter 17. — Expenditures of the Federal government by 
groups of objects, fiscal year ending June 30, 1920. 



As political unity and power grow, the citizens need less 
often protection against foreign foes, and they need more 
often, relatively, defense against the aggressions of some of 
their own countrymen. The preservation of domestic order 
requires police, courts of justice, and other agencies. The 
ideal of the anarchist to do without government is nowhere 



272 



TARIFF AND TAXATION [Ft. Ill 



realized. Everywliere there must be government to preserve 
peace and to protect property. Unfortunately, this need 
grows with the growing density of population. Crime in- 
creases when men swarm in great cities. The courts, which 
settle disputes between men, and which interpret their con- 
tracts, are agencies of peace, displacing physical contests. To 
maintain and operate the various parts of the social machinery 
requires ever-increasing governmental revenues. From many 
causes government has, in modern times, grown increasingly 

costly. 

§ 3. Social and industrial functions. The social and in- 
dustrial functions of government seem naturally to grow out 
of the primary ones just mentioned. In a democratic society, 
popular education is a necessity, as it appears that domestic 
order is not possible in a democratic state without intelligent 
citizens. The system of public education has, in many states, 
expanded to include a publicly supported university as the 
dominant educational and scientific organ of the community. 
Some industrial functions are performed by the government 
in connection with the primary needs. Lighthouses are 
necessary to guide the navy, but they also serve to guide the 
merchant marine and to aid industry. The post was estab- 
lished as an agent of political and military government to 
connect the ruler with the outposts (a fact the name post 
indicates), but the postal service has grown in every country 
to be a great industrial and social agency. The consular 
service, originating in the political need of keeping official 
representatives in foreign lands, has become a valuable eco- 
nomic agency; consuls are commercial agents, advancing the 
business interests of their countries in all quarters of the 
globe. 

§ 4. The enlarging sphere of the state. A mere police 
state would leave to private initiative the provision of every 
kind of economic agency not needed for political govern- 
ment. The state might, for example, even leave the provision 
of roads and bridges to private individuals or to companies, 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 273 

permitting them to charge tolls to obtain a return on their 
investment. Whenever a toll-road is made public and a toll- 
bridge becomes free, and the state maintains the roads, it is 
becoming less strictly a mere police state. Reacting from 
the ideal of the police state, which was most highly praised 
in the first half of the nineteenth century, the functions of 
government have been extending in many directions in the 
last half century. More and more, economic functions are 
performed through the agency of government. If we think 
of an act as done by the government for private citizens, we 
call it paternalism; but if we think of an act as done 1)1] 
citizens collectively for themselves, as the best way to get these 
things done, we may call it, in a broad sense, socialism, (mean- 
ing not a political party, but a principle of social action). 

Government is in one aspect a direct good to its citizens. 
In return for its collective cost, men collectively get the enjoy- 
ment of social organization, markedly in contrast with the 
uncertain ties and hazards of primitive communities. But 
government becomes also a mode of social investment, an 
indirect agent, a productive enterprise. Wealth applied 
through it secures in some cases a greater product than is 
possible by individual action. 

But when the government undertakes these various tasks 
the expense falls unequally on individuals and affects differ- 
ently their incomes. When free schools take the place of 
private schools, the law compels every one to contribute to 
education. To many individuals it is a matter of indifference 
whether they pay tuition or taxes, but the wealth}^ bachelor 
sometimes grumbles when forced to help in educating the 
day-laborer's family. The average result of a certain social 
policy may be right, but individuals diverge from the average 
and thus have constantly a motive to attempt to change the 
limits of governmental action. Happily, the subject is not 
always viewed with selfish eyes. The ethical and patriotic 
thought is not, "How will this affect my interests?" but, 
' ' How will it affect the general interests ? ' ' But, as the ques- 



274 TARIFF AND TAXATION [Pt. Ill 

tion of value is always involved, men are usually found favor- 
ing or opposing the industrial and social activity of the state 
according as it affects their own incomes. Thus the deter- 
mination of the sphere of the state is in large part an economic 
question. 

§ 5. Industrial revenues of governments. The costs of 
government at any stage are met in varying degrees in one 
of three ways: (1) from industrial sources, (2) by borrowing 
and thus creating a public debt, (3) from taxation. 

Receipts from industrial sources in the broad sense in- 
clude all rents from wealth owned, interest on loans made, 
and proceeds of sales from enterprises conducted, by the 
government. In feudal times, these were mostly obtained in 
the form of rents from the private domains of kings and 
nobles. In many early and medieval states these sources of 
receipts were adequate to the need of government; then they 
decreased in many countries, both relatively and absolutely, 
because of the sale of publicly owned wealth (lands and 
mines), and with the recent extension of the functions of gov- 
ernment have again increased very rapidly. Now industrial 
revenues come not only from the rents of forests, mines, docks, 
lands, and buildings, but from profits in the operation of in- 
dustrial enterprises, such as waterworks, railways, mines, and 
factories, and from interest on funds deposited in banks or 
otherwise invested. At present the industrial revenues of the 
aggregate governments of the United States (national, state, 
and' municipal) amount to about a fifth of all revenue re- 
ceipts. Since the middle of the nineteenth century the num- 
ber and variety of the industrial enterprises undertaken by 
governments has been steadily increasing, and this increase 
has been most marked in the cities. The change in this 
respect in the United States, great as it has been, has pro- 
ceeded more slowly than in the European countries. 

In 1913 the receipts of this nature (earnings of departments 
and of public service enterprises) were nearly $500,000,000. 
The larger part of this sum comes to the national government 



Cit. 17] OB.TECrS AXD PRINCIPLES OF TAXATION 275 

($288,000,000), mostly from the post-office department. Most 
of the remainder comes to the minor divisions ($176,000,000), 
and but little to the states. The total "earnings" (this means 
here receipts, not profits) of public service enterprises in 
incorporated places were $120,000,000. Revenues obtained 
by the sale of good§ are prices, such as water rates, or (if 
paid for the performance by an official for a service to 
legalize an act, as recording deeds, issuing licenses, etc.) are 
fees (frequently constituting the income, in lieu of salary, 
of the official, but sometimes paid into the public treasury). 

§ 6. Governmental receipts from loans. The funds to in- 
vest in these commercial undertakings are originally obtained 
in nearly all cases from public loans. Almost every unit or 
division of government may become a borrower to provide 
for its citizens at once certain needed advantages and im- 
provements when the funds are not at hand and immediate 
taxation is deemed too heavy a burden. 

The indebtedness (less funds available for payment of debt) 
of the aggregate governments of the United States in 1913 
was: 

Nation $1,028,000,000 

States 346,000,000 

Minor . divisions 3,47B,000,000 

Total $4,850,000,000 

The debts of the states and the minor divisions slowly 
and steadily increased after this date, and that of the nation 
leaped up in 1918 to $11,000,000,000 and in 1919 (at the 
maximum) to $25,000,000,000. 

Nearly all public debt other than national has been created 
for the purpose of peaceful social and industrial develop- 
ment. The debts of the American states have partly been 
made necessary to meet deficits in current expenses, but 
largely to construct canals, to erect public buildings, and of 
late to purchase forest-lands and to build roads. The minor 
divisions are counties, cities, villages, boroughs, towns, town- 



276 TARIFF AND TAXATION [Pt. Ill 

ships, and special districts for schools, drainage, irrigation, 
levees, fire protection, poor relief, roads, and various other 
purposes. Every one of them has more or less legal power 
to incur debts and to levy taxes for the purpose of paying 
the interest and of repaying the principal. The purposes 
for which the debts are incurred by specially organized 
districts are mainly indicated in the names (e. g., drainage, 
irrigation), while the regular political divisons of counties, 
cities, villages, towns, townships, incur debts for many objects, 
such as streets, sewage disposal, water supply, electric-light 
or gas plants, schoolhouses, libraries, and other public build- 
ings. Large expenditures for these purposes are necessary 
because the local governments are undertaking new functions, 
and either existing equipment (such as waterworks systems 
and street railways) must be bought from private companies 
or new ones must be built. They are necessary further be- 
cause the rapid growth of population calls for an immediate 
"capital investment," the payment of which may be, through 
borrowing, more easily spread over a series of years (e. g., 
in the extension of streets and paving and in the provision 
of schoolhouses for the children). 

The larger part of nearly every national debt has been 
incurred for war or preparation for war. The total debts 
of the national governments of the world just before the out- 
break of the Great War in 1914 were estimated at about 
$44,000,000,000.1 The total at the close of the war is esti- 
mated to be near $300,000,000,000.^ This amount has been, 
and will be, very largely increased in the later figures for 

1 These figures include the debts of the separate states in the federal 
unions of Australia and the German Empire, and the separate debts 
of European colonial governments, but not those of the states of the 
United States, and in no case including the debts of minor divisions, 
the total figures of which are not to be had. 

2 As computed by the statistician of the National City Bank, from 
figures at various dates from 1916 to 1920, the total was $279,000,000, 
000. 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 277 

the war period and for the after-war period, while almost 
everywhere expenses continue to exceed revenues. It is im- 
possible to appraise at all definitely the ultimate fiscal bur- 
den of these debts in the present disordered condition of 
the monetary systems and in the precarious state of the 
finances in many of the countries. Russia, under the Bol- 
shevik regime, has blankly repudiated its debt of $25,000,- 
000,000 but doubtless will reacknowledge parts of it ulti- 
mately as a condition to the establishment of its national 
credit. Numerous states are near the verge of bankruptcy 
and it is now impossible to predict what adjustments they 
may be forced to make with their creditors. The debts of 
some leading solvent countries, as estimated in 1920, are 

France, $46,000,000,000 

United Kingdom, .39,000,000,000 

United States, 24,000,000.000 

Italy, 18,000,000,000 

§ 7. Non-revenue character of receipts from loans. The 
proceeds from loans (and certain other items of sales) are 
called non-revenue receipts, because they are but' in anticipa- 
tion of receipts from other sources. The economic theory of 
such loans is essentially the same as that of private loans, but 
it is the people of the political district collectively that are 
the borrowers. To get the present uses of goods, they sell 
their promise to make future payments totaling a larger 
amount. The loan is the present worth of those promises. 
In the case of loans made for local purposes, provision is now 
usually made for their complete repayment within a definite 
number of years, usually ten, or twenty, or thirty. Mean- 
time interest is payable annually or semi-annually, and from 
some source an additional sum is collected to repay a part 
of the loan, sometimes by redeeming a certain part annually, 
sometimes by accumulating a sinking fund until that amounts 
to the whole debt. 

The minor divisions in the United States are thus con- 
stantly creating debts at the rate of about $2,000,000,000 each 



278 TARIFF AND TAXATION [Pt. Ill 

year, and at the same time paying former debts in instal- 
ments, in a total amount somewhat less than this. In the 
case of some municipal investments that are commercial enter- 
prises (such as those supplying gas, electricity, and water), 
these annual payments can be made out of the profits ; in the 
case of others, the payments come from special assessments 
upon the owners; and in most other cases they are collected 
by the usual methods of taxation. In America a large part 
of these costs are, by the law of special assessments, placed 
upon the owners of adjacent lands, whose outlays are usually 
more than offset by the increased value of their lands as a 
result of the improvements. In this case also, the present in- 
vestment is in anticipation of the future incomes which the 
owners of the improved lands will get. 

§ 8. Revenues from taxation. Much the largest part of 
the receipts of most governments, apart from loans, and in 
many cases nearly all such revenue receipts, come from taxa- 
tion. Tax (as a verb) meant originally to touch or handle, 
then to estimate or appraise, and then to charge a burden 
upon some one, especially to impose a payment of services, 
goods, or money upon persons or property for the support of 
government. Taxation is the legal process of taking in- 
come, services, or wealth from private persons for public 
uses. 

Taxes are of various kinds, but they always are incomes, or 
wealth representing future incomes, transferred from private 
ownership of the taxpayers to the government. In rare cases, 
more than the net current income of a certain kind may be 
taken for public uses. As economic income has ma,ny sources, 
it may be intercepted at many different points, and taxation 
may take various forms. The differences are so manifold 
that it is difficult to classify particular taxes satisfactorily. 
There are border-line cases where it is difficult to decide 
whether a particular payment to the government in the form 
of a fee, price, or special assessment is in the legal sense a tax 
or not. Some courts have, for example, decided that for 



Cii. 17] OBJECTS AND PRINCIPLES OF TAXATION 279 

certain purposes a special assessment is to be called a tax, 
and in certain other cases it is not to be if this would defeat 
the evident and just intention of the legislature, 

§ 9. Kinds of taxes. The following are the kinds of taxes 
most frequently referred to. 

(a) The simplest tax is a poll tax, a uniform amount pay- 
able by every person of the taxable class. This form of tax 
is being less and less used in America, and now amounts 
to little more than $17,000,000,^ this being only .6 of the 
1 per cent of the aggregate taxes in the United States. The 
national government gets about one fourth of this amount 
from a tax on immigrants, and the rest is collected by (some 
of) the states, counties, and minor divisions. Usually the 
poll tax is imposed only upon voters, as a condition to the 
right to vote. 

(b) Taxes may be laid upon incomes, as they come into the 
possession of the owner. Usually only monetary incomes that 
arise in commercial transactions are taxable, and no attempt is 
made to estimate the value of psychic incomes. Commer- 
cial incomes are more easily measured, but the omission of 
the other elements must cause many inequalities in the bur- 
den of the tax as between two individuals controlling 
equal incomes of real things. 

(c) Taxes may be on property, either general, upon all 
property in the taxing district, or special, upon certain forms 
of property. A property tax may be specific or ad valorem, 
in proportion to value, as to the method of its determination. 
Since the value of ma,terial wealth is the capitalization of the 
rentals at the prevailing rate of interest, a general ad valorem 
property tax, as far as it applies to material wealth, and if it 
were accurately assessed, would take an approximately equal 
proportion of wealth-incomes. It does not, of course, touch 
directly incomes derived from wages and salaries, but it re- 

3 The figures do not include returns from incorporated places having 
a population less than 2500, where the poll taxes may be a considerable 
sum. 



280 TARIFF AND TAXATION [Pt. Ill 

duces their purchasing power in many cases. It is in some 
respects more searching than a tax on actual rents, for it 
reaches the prospective, or speculative, rental. 

(d) Taxes may be on expenditure (sometimes called taxes 
on consumption) , This is but another mode of attacking in- 
come, for in the long run most income is spent, not always by 
the individual who earned it, but by some one, and thus it 
is reached by a tax on expenditure. Usually in the United 
States the tariff duties are accounted to be taxes on expendi- 
ture, as also the internal revenues (also called excises) of the 
national government. In time of war, internal revenues are 
extended in the United States to a multitude of articles, but 
usually they have been limited (with minor exceptions) to 
liquor and tobacco. Most of these taxes are in fact levied not 
at the time of purchase by the ultimate consumer, but upon 
the specific goods in the hands of some merchant or business 
agency, and' some of them are essentially special property 
taxes and others are business taxes of the kind next to be 
mentioned. 

(e) Taxes may be levied on selected agencies of industry 
or on the process of business; such are business taxes, licenses, 
taxes on investment in business, and corporation taxes. These 
burdens are diffused and rest eventually on some income, 
rarely to be ascertained exactly. 

§10. Defective tax "systems." The actual tax laws of 
each division of government in a country combine the various 
forms in different proportions. Most of the federal taxes -are 
from tariff duties and from internal revenues, the latter in- 
clude a variety of special business and property taxes and, 
since 1913, the federal income tax. The largest receipts of 
states, of counties, and of minor divisions are from property 
taxes, some special but most of them general in form. Among 
the various states a wide diversity is found. 'Some use the 
general property tax for all the divisions (state and local), 
while others (several of the northern states and California) 
have separated the sources of state and local taxation, taxing 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 281 

corporations for state purposes and most other forms of wealth 
for local purposes. Some states, particularly those of the 
South, make large use of licenses and taxes on business both 
for state and local purposes. 

The tax laws of many states have been much modified of late 
and are still in process of change. It is only in a loose sense 
that one can speak of the tax "system" of any state, made 
up as it is of so many diverse elements, each used to tap in 
some independent way some source of private income for 
public purposes. Everj^ tax "system" has grown up more 
or less accidentally, guided by no more of a general principle 
than the advice of the cynical old statesman — so to pluck 
the feathers of the goose that it will squawk as little as 
possible. Thus, everywhere, the existing situation must be 
largely accounted for by custom and ignorance, by the weak- 
ness of some classes and the undue influence of other classes, 
rather than by clearly thought out principles soundly ad- 
ministered. 

§ 11. Various standards of justice suggested. There have 
not been lacking earnest attempts to arrive at some general 
principles. Various standards have been suggested to meas- 
ure the distribution of the burden of taxation, the chief 
being benefit, equality, ability, sacrifice, and social welfare. 
Each of these terms is capable of various interpretations 
which have changed from time to time. The benefit de- 
rived by any citizen from most of the public services evidently 
cannot be applied in any literal sense to strong and weak, 
to rich and poor. It is possible, however, to interpret equal- 
ity with reference not to objective goods, but to the psychic 
sacrifice occasioned by taxation. Ability is of many kinds 
and may be differently understood. Some think ability to 
bear taxation is "in exact proportion to the money income"; 
others believe that it increases at a greater rate than money 
income, and favor, therefore, progressive taxation, that is, 
higher rates on the larger incomes. The standard of 
sacrifice is closely related to that of ability, looking, how- 



282 TARIFF AND TAXATION [Pt. HI 

ever, to the psychic effect of depriving the taxpayer of his 
income. It lends itself even more readily than does the 
standard of ability to the application of the marginal princi- 
ple of valuation, and results in progressive taxation, 

§ 12. Social welfare as the aim. The conflicting interests 
of the various classes of taxpayers in each period are to some 
degree softened by the prevailing public opinion, sometimes 
called the social conscience, and taxes are adjusted according 
to a vaguely held ideal of the social welfare. Social expedi- 
ency, more or less broadly interpreted, determines who shall 
be taxed and what social results are to be sought. The exemp- 
tions from taxation in feudal times were great and, viewed 
from our standpoint, were inequitable, for the upper classes 
escaped while the peasants bore most of the burdens. The 
landlords and nobility, who were assumed to be performing 
important social functions, generally had outgrown their use- 
fulness in the period preceding the French Revolution, which 
swept away many of these abuses. 

Exemptions from taxation are granted liberally in most 
states to-day on some kinds of wealth and to some classes of 
citizens, because of their supposed relations to the public 
interest. Real estate and equipment devoted to educational^ 
religious, and charitable purposes, the homes of priests and 
ministers, homesteads purchased with pension money, as well 
as all public lands, buildings, and equipment, are exempt. 

The social interest requires that taxes be both elastic and 
productive, so that the needs of the government shall be amply 
provided for. The harmonizing of these needs in the laws of 
taxation requires a high degree of wisdom, of foresight, and 
of integrity in the legislator and in the citizen. No hard-and- 
fast rule for the apportioning of taxes can be laid down. The 
decision must be made in each generation by the public opinion 
as to what is most expedient for the general welfare. 

§ 13. Principles of administration. Whatever forms of 
taxes are adopted, whether on property or income, whether at 
proportional or at progressive rates, their justice and ex- 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 283 

pediency depend largely on their administration. Principle 
and practice in this, as in most affairs, may go far apart. The 
administration of taxation should be economical, certain, and 
uniform. (1) Some laws are more easily and economically 
executed than others. The time of collection should be as con- 
venient as possible for the citizen, and the mode of payment 
should be the most simple. (2) The utmost certainty is desir- 
able as to the time, method of payment, and amount. Taxation 
that, in its principle, is variable, shifting, or dependent on 
personal whim and favoritism, is despotism. (3) But the 
greatest evils, in practice, result from failures in uniformity as 
between individuals. The assessment of taxes has to be 
intrusted to men with fallible judgment, imperfect knowl- 
edge, and selfish interests. The assessor is as near a 
despot as any agent of popular government to-day. Not 
infrequently men of proved incapacity in every private 
business they have attempted are, for partizan or cor- 
rupt reasons, selected as assessors, and are given the power of 
passing judgment on the value of millions of dollars ' worth of 
property. Under the circumstances, evils are to be expected, 
and they occur. The small owner often is crushed under the 
unequal assessment, while the large owner comes off lightly. 
Political friends are favored, political foes are made to suffer. 
Even the most honest and capable of assessors find in the 
imperfections of the tax laws * an insuperable obstacle to 
even-handed justice. 

§ 14. Shifting and incidence. The person paying a tax 
into the public treasury is not always the one whose income is 
reduced in the long run. This is most clearly seen in the ease 
of taxes paid by middlemen. In most cases the final and 
regular burden of the tax is distributed over a number of in- 
comes. The passing on of the burden is called the shifting of 
the tax ; the final location of the burden is called the incidence 
of the tax. The lawmaker cannot tell exactly where the weight 
will fall. The principles of value give some guidance in the 

4 Particularly the difficulties noted in the next chapter, §§ 2-5. 



284 TAEIFF AND TAXATION [Pt. Ill 

inquiry, but the workings of the principle are difficult to 
follow. 

Consider a situation where certain taxes have been for some 
time levied. They have become a part of the general adjust- 
ment of prices. If paid by any one in business they may be 
looked upon as a deduction from the gross proceeds or product 
of the business, prior to cost, or as a part of cost.^ In either 
case, every one choosing that business does so in the light of 
this fact. Unless the business promises to yield as good in- 
comes (wages, profits) as other lines, the number engaging 
in it, and the output, must diminish, and thus the price of the 
product rises, or the cost of the factor falls, or both in some 
proportion. The tax on any durative agent or on any es- 
tablished business thus becomes incorporated after a time in 
its price and in the prices of the products, and any purchaser 
pays a price based on the net income remaining to the owner 
of the wealth after the tax is paid. Viewed in this way, taxes 
are seen to be borne to some extent by every one, by those who 
do not as well as by those who do actually meet the tax-col- 
lector face to face. The citizen with no taxable property is 
affected, far more than he realizes, by extravagance of gov- 
ernment and by inequities in taxation, for the effects of most 
taxes are diffused so that every self-sustaining member of the 
community has some share in them. 

§ 15. Taxes as costs. Now, if a new tax is levied, or an 
old tax changed in amount or in its incidence, it becomes a 
new influence in industry. Some occupations are made more 
attractive, others less so. Some places are made more, others 
less, desirable to live in. Property thus fluctuates in value, 
and investments become more or less remunerative. If the 
new tax reduces the net income of any productive agent, it 
reduces likewise its value, which is but the capitalization of 
its net rental. If taxes are taken off factories and put upon 
farm rents, factories rise and farms fall in value in the hands 
of their owners. The immediate change in value is much 

» See Vol. I, p. 374. 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 285 

greater than the annual tax, for if five dollars is to be taken 
permanently from the annual rental of the farm, nearly one 
hundred dollars is taken at once from its selling value when 
the prevailing yield on investment is 5 per cent. The rate of 
adjustment varies greatly under different conditions, and the 
inflow and the outflow of labor and capital are more or less 
rapid in the various industries. 

Taxes that enterprisers are unable to shift to others are 
reckoned by them as a part of their costs of production when- 
ever the conditions of competition and of substitution make 
it possible to do so. Every new tax that curtails the supply 
of any necessary agent must raise the price of the products 
and cause more or less of the tax to fall upon the consumers. 
In the Civil War an increase in the tax on whisky increased 
its selling price, and distillers who owned stocks on which a 
smaller tax had already been paid reaped profits of millions 
of dollars. When the tax on tea was increased in England, 
all dealers that had accumulated a stock before the law went 
into effect were gainers. Every change in taxation inevitably 
affects, either favorably or unfavorably, many interests. The 
chance to anticipate a change in tax laws, or to get, from those 
in power, information of a proposed change, makes speculation 
possible and political corruption profitable. 

The fact that a change in taxation is a disturbing element 
in price is not to be deemed insignificant merely because "all 
comes out right in the end." Every change in taxation is 
an element of uncertainty in business and increases the for- 
tunes of some men at the expense of others. Hence no con- 
siderable change should be made without good reasons in its 
favor. The older taxes have the virtue of stability, but in 
many cases they have grown out of harmony with the indus- 
trial conditions. While, therefore, from time to time there 
is a real need of a reform in the tax system, it should not be 
undertaken without recognizing the many and complex inter- 
ests involved. 

§ 16! Taxation and socialism. Because of its effect on 



2S6 TARIFF AND TAXATION [Pt. Ill 

costs, the taxing power gives to the government a means of 
encouraging some and of discouraging other persons and in- 
dustries. "The power to tax is the power to destroy," is 
the notable dictum of the Supreme Court. At the same time 
it is the power to favor and to enrich the favored. So it 
is but to be expected that, under the guise of taxation, 
greedy men, mistaken reformers, sentimentalists, and true 
philanthropists should constantly attempt to upbuild or to 
destroy the chosen objects of their favor or of their antago- 
nism. Taxation has been used, for example, to make impos- 
sible the issue of bank-notes by state banks, to discourage 
the use of whiskey and tobacco, to prohibit child labor, to 
decrease the use of oleomargarine, and to upbuild chosen 
industries. The purpose in such legislation is sometimes 
subtle, at other times frankly recognized. Rarely is it ad- 
mitted, however, by those who use taxation as a means of 
interference with the ordinary course of business, that this 
is socialism in the correct sense of the term.*' Many active 
business men who generally oppose any interference with 
private business, and strongly denounce as socialism the use 
of legislation intended to favor the weaker industrial 
classes, nevertheless support a ''protective" tariff. But a 
protective tariff is intended to make selected industries more 
profitable than they would be if left to the usual rule of 
supply and demand, and it compels men in other industries 
to cease exporting goods, and forces many others to pay 
higher prices than they otherwise would. That such use of 
the taxing power, either with selfish or unselfish purposes, 
will cease, is not to be expected; but it is well to recognize 
the true nature of the case, and to watch carefully the re- 
sults. 

6 See ch. 34. 

References. 

Bullock, G. J., Selected readings in public finance. Bost. Ginn. 

1920. 
Daniels, W. M., The elements of public finance. N. Y. Holt. Pt. II, 

chs. I-V. 1904. 



Ch. 17] OBJECTS AND PRINCIPLES OF TAXATION 287 

Library of Congress. List of References on Municipal Finance and 
taxation. Washington. 1920. 

Plehn, C. C, Public finance. 4th ed. N. Y. Macmillan. 1920. 

Seligman, E. R. A., Essays in taxation. 8th ed. N. Y. Macmillan. 
1913. 

United States Census, 1910. Volume on wealth, debt, and taxation. 

Willoughby, W. F., The movement for budgetary reform in the States. 
P. 254. New York. Appleton. 1918. 

Willoughhtf. W. F., The problem of a national budget. N. Y. Ap- 
pleton. 1918. 



CHAPTER 18 



PROPERTY AND CORPORATION TAXES 

§ 1. Importance of taxation as a public question. § 2. The general 
property tax; nature and difficulty. § 3. Ambiguity of the term "prop- 
erty." § 4. Various temporizing policies. § 5. A consistent policy of 
wealth-taxation. § 6. Needed reform of assessment. § 7. Separation of 
state and local taxation. § 8. Federal taxation of commerce. § 9. 
Proposal of the single tax on land values. § 10. Various reforms in 
land taxation. § 11. Difficulties in taxing corporations. § 12. Special 
taxes on banks. § 13. Special taxes on insurance. § 14. Special 
taxes on transportation. § 15. Alternative policies in corporate tax- 
ation. § 16. General plan for corporate taxation. 

§ 1. Importance of taxation as a public question. The 

discussion of taxation has accompanied the growth of free 
government in England and America from the time of Magna 
Charta. The control of the public purse has been found to 
give; the key to political power, and therefore it has frequently 
become the occasion of conflict between the monarch and the 
people. But in our own national history, since the adoption 
of the Constitution, taxation has not had a leading place in 
politics except in the one aspect of the tariff. The constitu- 
tional question of states' rights long absorbed most of the in- 
terest of citizens and of legislators. But, with the quickened 
attention of the public to economic questions, the problem of 
taxation became of increasing importance. 

It has come to be recognized that taxation can be made to 
play, and is bound to play, a leading part as an agency in the 
distribution of wealth, and thus it is the center of much of 
almost every proposal of social change and betterment involves 
the ardent controversy regarding social reform. Ultimately, 
some cost. The question then must be answered, Who is to 

288 



Ch. 18] PROPERTY AND CORPORATION TAXES 289 

receive the benefits and upon whom and how shall new taxes 
be levied to pay the cost ? Further, it is often urged that this 
result of taxation in redistributing incomes is in itself (or 
can be made) a virtue; and some even see in tax reform the 
answer to the largest social questions of our time. We are 
now to take up a few of the more important problems of taxa- 
tion, to see the difficulties, and to suggest the direction in which 
their solution is to be sought. The tariff having been already 
separately considered, the chief kinds of taxes we have here to 
treat are property taxes, general and special, and inheritance 
and income taxes. 

§2. The general property tax; nature and difficulty. 
The general property tax is a tax of which the rates both 
of assessment and of levy are uniform and equal in proportion 
to the value of all (or nearly all) property in the taxing 
district.^ There are always some exceptions of certain kinds 
of property, or of the property of certain persons, or of prop- 
erty and things put to certain uses— public, educational, 
religious, and charitable in their nature. 

The federal government levies no general property tax, but 
the other branches of government ^ receive about three fifths 
of all their revenues from it. 

At first view nothing would seem to be simpler and juster 
in principle than such a plan of taxation ; but those who have 
most carefully studied its practical operation, almost with 

1 For example, the constitution of Alabama declares : "All taxes 
levied on property in this s;l;ite shall be assessed in exact proportion to 
the value of such properly," etc. And the constitution of Indiana de- 
clares: "The general assembly shall provide, by law, for a uniform 
and equal rate of assessment and taxation of all property, both real 
and personal, excepting," etc. Similar statements occur in most state 
constitutions. 

2 ITie general property tax in the United States constitutes : 

Of the revenue receipts of the states 38 per cent. 

Of the revenue receipts of the counties 76 per cent. 

Of the revenue receipts of the incorporated places . . 60 per cent. 
The total amount collected in this way in 1913 was over $1,083,000,000. 



290 TARIFF AND TAXATION [Pt. Ill 

one accord pronounce it to be a " dismal failure. ' ' The chief 
reason assigned for this failure has been that the assessment 
of the tax is imperfect and incomplete because of the in- 
competency or dishonesty of officials. The usual thought 
is that if all property could be justly assessed the plan would 
be excellent. Undoubtedly the difficulty of just assessment 
has its part in the weakness of the tax ; but back of and more 
important that this is an inherent fallacy in the apparently 
simple principle of the tax. 

§ 3. Ambiguity of the term "property." Unfortunately, 
the word property is applied, even by the most competent 
courts, both to the intangible right of ownership (the funda- 
mental meaning) and to the concrete thing that is owned, the 
source of the income.^ But apparently the value of the right 
to the income yielded by a house, for example, is merely the 
value of the house. The value of the property in the one 
sense (the abstract ownership, the intangible right) is merely 
a reflection of the value of the property in the other sense 
(the concrete wealth). There are not here two independent 
bodies of economic wealth. Whatever value belongs to the one 
is subtracted from the other. Nor is it rational to take the 
paper document called a deed (which is but the evidence of 
ownership) and call it tangible property having a value in 
addition to the house itself. Yet, in fact, all these confusions 
are constantly made in taxation. The term "intangible per- 
sonal property" is applied to such things as mercantile credits, 
promissory notes, bonds — in general to the right to collect 
sums from another person, whether these rights arise out of 
sales or of loans — and all are treated as parts of taxable 
property. Sometimes the evidences of indebtedness, the 
promissory notes or the mortgage papers, are even called 
tangible property, the same term that is applied to land, houses, 
and machinery. By universal practice supported by a long 
line of court decisions, these rights (whether evidenced by 
paper or not) are made subject to taxation, except as by 

3 See Vol. I, pp. 264-267. 



Cir. IS] PROPERTY AXD CORPORATION TAXES 2ni 

piecemeal legislation certain grudging exceptions have been 
made. These views and this practice are supported by the 
popular desire to tax money-lenders. The result is "double 
taxation" of many sources of income. This involves a burden 
that is ruinous in some cases, both to borrowers and to lenders, 
and that tempts in all cases to the evasion of the tax. 

Take, for example, a house assessed at $10,000 which is 
owned free of debt and which has a rental value of $600. 
If the rate of taxation is 1.5 per cent, the tax paid would 
be $150. Now if the owner borrows $8000 he is still taxable 
$150 on the full value of the house, and the lender nearly 
everywhere is taxable on the amount of his mortgage, 
which would be $120 additional. The total tax payable 
out of the one source of income, the house, is then $270. The 
same analysis will show that any credit is but a contractual 
claim upon some other source of income which is, or should 
have been, already taxed. 

If one person owns all the capital-value invested in a 
specific piece of wealth, no attempt is made to tax both the 
capital and the wealth; but if it happens that two or more 
persons share the capital-value invested in the same wealth, 
the attempt is made to tax as a unit the full value of the 
wealth and, in. addition, some part of the capital also. It is, 
however, easy in most cases to conceal this "intangible prop- 
erty" from the assessor's eyes, and a comparatively small 
amount of it is ever taxed. This means inequality and hard- 
ship in the operation of the tax and, as a result, unceasing 
temptation to perjury by the taxpayer and to favoritism and 
graft by public officials. 

§ 4. Various temporizing policies. The general property 
tax in practice is now usually unjust and demoralizing. 
What, then, shall be done about it? Various policies 
have been followed. One has been to declare that the 
law would be good if it could be enforced, but that 
as in practice it cannot be, the best thing is to go on 
as before, catching a few "tax-dodgers," and letting the 



292 TARIFF AND TAXATION [Pt. Ill 

rest go. Another policy is to hire "tax ferrets," paying 
them large commissions to discover cases where intangible 
property of this sort has been concealed from the assessors. 
This method, even when most stringently applied, has never 
reached more than a small proportion of the cases, and be- 
comes a potent agency of political favoritism and corruption. 
Another policy is to maintain the general principle, 
but to make exceptions here and there. Usually the excep- 
tions are made just at those points where the law would with 
earnest effort be most easily enforceable, and therefore where 
it has become most inconvenient. As a result of these changes 
the state laws display a bewildering and illogical variety. 
By constitutional interpretation. United States notes and 
federal bonds are exempt from state and local taxation; gen- 
erally, by state law, building and loan associations and savings- 
bank loans are exempt, as, in a majority of states, are state 
and municipal bonds if held within the state. In at least eight 
states, bonds of the state are exempt, but those of the munici- 
palities are taxable, while in a few states the reverse is the 
case. In several states both kinds of bonds, when issued after 
specified dates, are exempt, but in Ohio state bonds are exempt 
only if issued prior to 1913. All but seven of the forty-eight 
states, however, attempt to tax the resident holders of state 
and municipal bonds of other states ; but the exceptional states 
are those in which most of the investors in this class of securi- 
ties reside. In many cases private debts receivable are al- 
lowed to be offset against debts payable. In some states mort- 
gages on real estate are exempted or (in Massachusetts) treated 
as an interest in the real estate. Rarely mortgages are ex- 
empted up to a certain amount (in Indiana to $700, the pur- 
pose being to tempt the borrower to reveal the name of the 
lender). Sometimes a special mortgage registration tax, 
payable but once (New York % of 1 per cent),, is levied, 
and otherwise mortgages are free from taxation. Small as 
this rate is, the fiscal yield under this plan exceeds that for- 



Ch. IS] PROPERTY AND CORPORATION TAXES 293 

merly obtained from mortgage taxation under the general 
property tax. 

By the overlapping of these laws, so contradictory in prin- 
ciple, it may happen that securities held by taxpayers residing 
in other states than those of the issue are taxable two or three 
or more times; but few if any loans of this kind are made 
except by those evading all taxation, 

§ 5. A consistent policy of wealth-taxation. These excep- 
tions still leave the law in its general principles as to the taxa- 
tion of intangible property illogical and unjust. A solution 
can be found only by abandoning the ambiguous legal concept 
of property and making use of economic concepts. A con- 
sistent tax law might take either wealth or capital as the basis 
of assessment, but not sometimes the one and sometimes the 
other. Wealth is an impersonal basis of taxation; each piece 
of wealth might be taxed once as a unit no matter how the 
ownership were divided. Or the other alternative might be 
chosen. Capital would be a personal basis of taxation; each 
person's capital might be taxed, no matter from what sources 
the incomes were derived (the concrete wealth, of course, then 
being left untaxed). 

The wealth basis is much nearer to the present general 
property tax as actually administered. The assessment of 
general tangible wealth would undoubtedly be more easily 
done than would that of individual capitals, and likewise be 
both easier and juster than the present inconsistent policy. 
Tangible things are comparatively easy to find, measure, and 
evaluate where they are, and if they are all taxed it is evi- 
dently the same as if all the capital values based upon them 
were taxed in the owners ' hands. The various equitable claims 
of different owners in one source of income could be left to 
adjust themselves through shifting, mainly in the choice of 
investments, once the plan had become generally applied. 

In legal theory a distinction is sometimes made between 
qualified and unqualified rights of property. Unqualified 



294 TARIFF AND TAXATION [Pt. Ill 

property covers all the rights of ownership in a specific piece 
of wealth, for example, in a house and lot held in fee simple 
and unencumbered; qualified property is any portion of the 
total as modified and limited by another 's right ; for example, 
the rights of a mortgagor and of a mortgagee in the house 
are both qualified. The application of these conceptions to 
questions of taxation would have led legislators and judges 
to a very different understanding of the general property 
tax, quite like that above suggested. And this way out 
of the present difficulties is open to any court that will use 
it. But, unfortunately, as far as appears, the courts in deal- 
ing with the subject have failed to recognize the usual 
qualified nature of property rights. 

§ 6. . Needed reform of assessment. The assessment of the 
present general property tax is in many communities 
notoriously inefficient and unjust. The root of most of the 
present evils (other than those above discussed) is the 
method of local election of assessors, which usually is 
by townships, but in some cases by counties. The local 
assessor's estimate of value is used as a basis for taxa- 
tion not only for his district but for the larger units 
(county and state). Thus every local assessor is tempted 
by the conflict of interests not only among the taxpayers in 
the district which elects him, but by the conflict of interests 
between his district as a whole and other districts. The lower 
the ratio of assessment to true valuation in any township com- 
pared with that of the other tax districts, the smaller the pro- 
portion of county and state taxes that the people of the district 
have to pay. Willingness to under-assess property often be- 
comes thus the chief virtue of an assessor in the eyes of his 
political constituents. This has led in many cases to absurd 
under-assessment, which boards of equalization have proved 
powerless to remedy in any great measure, A sounder plan 
would be general state assessment, with a permanent expert 
board of commissioners employing a corps of state assessors 
under the merit system of appointment. This plan has as yet 



Ch. 18] PROPERTY AND CORPORATION TAXES 295 

beeu applied onlj'^ to assessment of railroads and some other 
public-service corporations. 

§ 7. Separation of state and local taxation. For the rea- 
son just indicated the failure of the general property tax has 
been most conspicuous where it is used as a basis for state 
taxation. This has led some financial students to advocate the 
plan of separation of state and local taxation. This means 
the assignment of certain sources of revenue (such as corpora- 
tions and the liquor business) primarily or exclusively to the 
state, leaving all real estate and the general property of non- 
corporate persons to be taxed by the counties and minor divi- 
sions under the general property tax. The plan has been 
increasingly applied in New York, until, in 1906, it became 
almost complete. In 1910 the plan was adopted in California ; 
and it is largely used in New Jersey, Connecticut, Delaware, 
and Pennsylvania, and to a small extent in some other states. 
An efficient state assessment of general wealth would accom- 
plish most of the advantages claimed for this plan, while 
avoiding some of its dangers. 

§ 8. Federal taxation of commerce. Customs and in- 
ternal revenue (including the income tax) constitute the 
chief revenues of the federal government. Unlike the gen- 
eral property taxes, these are not levied upon the main body 
of wealth held in possession, but upon income as it accrues 
or upon articles of merchandise in course of trade and upon 
business activities. Stamps on receipts, checks, deeds, 
bills of sale, and licenses on the sale of liquor and 
tobacco are taxes on business acts which are necessary to the 
acquisition, use, or expenditure of wealth. Goods imported 
are taxed at the time of entering the country ; domestic prod- 
ducts, such as cigars, spirituous or malt liquors, playing cards, 
and (at times) matches, pig iron, and other products, are taxed 
usually at the time of exit from the factory. 

It has already been shown that when the tariff duty pre- 
vents the importation of foreign goods and by raising the 
price encourages domestic manufacture of the article, there 



296 TAEIFF AND TAXATION [Px. Ill 

is virtually taxation of the consumer to subsidize the private 
manufacturer. A system of properly adjusted compensatory 
duties (tariffs and internal duties combined) which would 
prevent tariff duties from having any prohibitive effect could, 
in a great country like ours, be made to produce any revenues 
desired. Such a system, combined with the federal income 
tax, seems destined to be the chief dependence for the national 
government. 

The increasing needs of revenue between 1913 and 1920 
led to the development of many forms of federal .taxation 
on business. The most important of these, under the names 
of the taxes on corporate incomes and excess profits, will 
be, more fully discussed with the income tax, with which, 
though of a different nature, they have been closely con- 
nected in legislative development. 

§ 9. Proposal of the single tax on land values. Besides 
the general property tax, there are found in the country as a 
whole a large number of special property taxes. Some of 
these have been introduced as substitutes for the general 
property tax; such is the special taxation (above referred to) 
of mortgages, and bonds. Other special property taxes have 
been introduced because they were believed to be good in 
themselves; such are special franchise taxes on corporations 
and some kinds of taxes on land. A much more drastic 
policy of special taxation of land, or of land values, was 
proposed by Henry George and has been advocated by his 
followers since the publication of his remarkable book "Pro- 
gress and Poverty" in 1879. The doctrine there set forth 
is that the state should "appropriate land rent by taxa- 
tion," should "tax land values, irrespective of improve- 
ments." It is maintained that a "single tax" of this 
kind would be quite sufficient for all the purposes of 
government. The main arguments adduced for this plan 
may be reduced to three propositions: first, private prop- 
erty in land is essentially unjust, because land is made by 
nature, not by man ; second, the plan would make assessment 



Ch. 18] PROPERTY AND CORPORATION TAXES 297 

simple and certain by limiting it to the unimproved land and 
making unnecessary the more difficult assessment both of 
tangible improvements and of intangible personal property; 
and third, it Vould work a marvelous reform in social con- 
ditions, abolishing poverty and greatly increasing produc- 
tion. 

It is impossible within our limits of space to discuss this 
proposal further than to indicate that : ( 1 ) It assumes an un- 
tenable theory of property.* (2) It overlooks the difficulty of 
distinguishing the value of the land, ' ' irrespective of improve- 
ments," from that of the land as it actually is, a difficulty 
especially great in the case of agricultural land.^ The diffi- 
culty is present even in the case of urban land when the im- 
provements of filling, draining, and leveling have become in- 
corpoi'ated with the site.*^ (3) The plan ignores the stimulus 
(motivating force) which private ownership has given and still 
gives to the maintenance and fuller productive use of land. 
Nowhere has production thriven where the state was the uni- 
versal landlord. 

§ 10. Various reforms in land taxation. While the single 
tax plan is defective in principle, its wide discussion has 
served to direct attention toward the need of reform in the 
taxation of land. Some proposals looking toward this end 
are widely favored by opponents as well as by advocates of the 
single tax. Such are the following: 

(a) The abandonment of the taxation of mortgages.^ 

(b) A more correct assessment, in accordance with the pres- 
ent laws, of lots and lands held for speculative purposes, 
which in usual practice are now greatly under-assessed. 

(c) More adequate special franchise taxation upon corpora- 
tions for special privileges in the public highways. 

(d) Exemption, in value equal to the costs, of improvements 

4 See ch. 32. 

6 See Vol. I, pp. 116, 117, 145, 445-455. 

6 See Vol. I, pp. 117, 146, 453. 

7 See § 4 and § 5. 



298 TARIFF AND TAXATION [Pt. Ill 

on land, such as buildings, drains, fences, and fertilizers, for a 
limited time after they are made, perhaps five years. 

(e) The separate assessment of urban lands used as mere 
building sites and of the buildings on them. 

(f) Taxation of the increase ("increment") of urban land 
values, periodically or on the occasion of transfer of owner- 
ship. 

§ 11. Difficulties in taxing corporations. Until near the 
second quarter of the nineteenth century, business corpora- 
tions (of which there were few) were taxed just as was the 
general property of individuals, excepting that fees were 
charged, usually payable but once, for the incorporation 
of new companies, or at times of increasing the capital 
stock of an old one, variously called taxes on corporate 
charters, license taxes, incorporation fees, organization 
fees, and charter fees. This still continues to be the 
case in the main in most of the states. The methods and ma- 
chinery of assessment were (and still are) essentially local 
and simple, and have proved to be inadequate to reach or justly 
assess the larger and more complex corporate enterprises when 
their equipment and business extend beyond town, then county 
and, finally, state lines. Moreover, the corporate forms of 
organization presented in complex and puzzling ways the dual 
conception of property.^ Here was the tangible wealth of 
the corporation, and there were the diffused rights of owner- 
ship, the capital of individual stockholders and bondholders. 
Cdnfused by this ambiguity, the men of that time believed (as 
many still believe) that there were here two separate and justly 
taxable funds of value, the tangible wealth and the paper 
evidences (or the mere intangible rights) of ownership. The 
popular view was, and still is, that "all kinds of property 
ought to bear their fair share of the burdens of taxation." 
The real question is, what is "fair"? To treat the object 
owned and the right of ownership (or the equity in it) 
as separate bodies of property is surely double taxation, 

8 See above, § 3. 



Ch. 18] PROPERTY AND CORPORATION TAXES 299 

and results in confiscation in many cases. Between this 
doubt and the practical difficulty of assessment, it turned 
out that corporate wealth, far from being doubly taxed, 
was largely escaping even its due single burden. 

§ 12. Special taxes on banks. Attempts to deal with the 
difficulty without clear perception of its cause took the form 
of legislative tinl^eriug and patching. Taxes were gathered 
from corporations by any device that seemed workable. The 
banks, being the earlier important corporations, were first 
experimented upon. Taxes on capital stock and on circula- 
tion were tried first (in 1805, by Georgia), then a tax on divi- 
dends (in 1814 in Pennsylvania, and in 1815 in Ohio), ex- 
amples that were followed or modified by a number of states. 
After the national banking system was started in 1864, at- 
tempts to tax both the capital of the banlfs and the stock in 
the hands of individuals led to federal court decisions and then 
to state legislation, by which now in many of the states the 
banks are separately taxed on their real estate and the shares 
are assessed to the individual holders (by various rules), but 
the taxes deducted from dividends and paid by the bank. 
There are, besides, special franchise taxes and fees paid by 
banks in various states. 

§ 13. Special taxes on insurance. Insurance companies 
present in a striking manner the complexities of the am- 
biguous property concept. The assets of the insurance 
companies (we refer here particularly to the reserve com- 
panies), which belong in equity to the policy-holders (less the 
claim of the stockholders in the case of the stock companies), 
are nearly all invested in stocks and bonds of corporations and 
in mortgages on real estate. Now, under the general property 
tax, strictly interpreted, the policies are assessable at their 
surrender or reserve valuation in the hands of the policy-hold- 
ers; secondly, the securities and credits that compose the 
assets are assessable to the company; and, thirdly, the 
railroads, factories, and houses, built with the outstanding 
loans made by the insurance companies, are assessable as 



300 TARIFF AND TAXATION [Pt. Ill 

tangible wealth to the various owners (individuals or, usually, 
corporations) of the wealth. Even more complex problems 
may and do arise. If such an interpretation were practically 
enforced it would result in double or multiple taxation 
levied upon the same economic source, and would be utterly 
prohibitive of the insurance business. The enforcement has, 
however, been impossible in practice. Insurance companies 
have comparatively little tangible wealth excepting real estate 
for offices. This is taxed locally. Several methods have been 
tried (beginning as early as 1824) to make insurance com- 
panies pay taxes (usually for state purposes) on something 
besides tangible wealth. A tax on receipts from premiums 
proved most workable, first as applied to "foreign corpora- 
tions" (that is, to those of other states) and later, generally, 
to domestic companies also. Now, amid bewildering variety 
and interstate rivalries in tax laws, the most usual rate is 2 
per cent on gross (in a few cases on net) premiums collected. 
The taxes on premiums, with various licenses and fees, now 
amount to 2.15 per cent of the total receipts from life insur- 
ance premiums in the United States. This is taxation not on 
an existing body of accumulated wealth, or upon income, but 
upon the process of accumulation, a tax directly on the act of 
saving. A consistent policy of wealth taxation, combined 
with income taxation, would require the abandonment of the 
present forms of special insurance taxes. 

§ 14. Special taxes on transportation. Another great 
group of businesses whose taxation has been especially com- 
plex, because they are distributed throughout different taxing 
districts, are agencies of transportation and communication, 
especially railroad, sleeping-car, express, telegraph, and tele- 
phone companies. A state tax on railroad tonnage (Pennsyl- 
vania, 1860) was declared unconstitutional by the United 
States Supreme Court. But many other plans have been tried 
to compel the railroads to contribute, the chief being by taxes 
on dividends, gross earnings, equipment, and valuation of 



Ch. IS] PROPERTY AND CORPORATION TAXES 301 

capital stock, taxed either to the company or to the stock- 
holders, (Connecticut since 1849). About a third of the states 
no longer make the physical plant the basis of taxation, ex- 
cept that in most of them some part or kinds of real estate 
are taxed locally.^ 

Telegraph companies are still locally assessed in most states, 
but in more than a third of the states are taxed either on gross 
receipts or on mileage of wire. Telephone companies are sim- 
ilarly taxed, but sometimes on the number of transmitters, or 
of subscribers, or on each plant, or otherwise. In a similar 
manner, express and sleeping-car companies are taxed, in the 
same group of states, on mileage, or on capital stock propor- 
tional to mileage, or by license and privilege taxes. 

In the case of these corporations, and also of various other 
miscellaneous kinds of companies, no clear-cut principles serve 
to guide. The result is "a chaos in practice — a complete ab- 
sence of principle." ^° 

§ 15. Alternative policies in corporate taxation. If 
the taxation of corporations is not to continue to be treated in 
a mere hit-or-miss manner, with every possible kind of incon- 
sistency among the various states, some general principles 
must be recognized and some clear policy be formulated. But 
there is no general agreement to-day among jurists and econ- 
omists upon a definite and consistent plan in this matter. 

Two alternative policies appear. The first is to make the 
scheme for taxing corporations quite different in principle 
and plan from that for taxing natural persons. The assump- 
tion in this is that the "general property tax" is an irreme- 
diable failure, and is particularly inapplicable to corpora- 
tions. This plan goes along with the separation of state and 
local taxation.^^ An unfortunate result of this is to relieve 
the great mass of taxpayers of the state from any apparent 

9E. R. A. Seligman, "Essays on Taxation" (1895), p. 156. 

10 Seligman, op., cit. p. 136. 

11 See above, § 7. 



302 TAEIFF AND TAXATION [Pt. Ill 

and measurable part of the tax burden for state purposes, and 
thus to separate responsibility and power in state government. 
This policy nevertheless is favored by some of the leading au- 
thorities on finance. 

The other policy is to tax the wealth and business of cor- 
porations (excepting those enjoying special privileges) in 
essentially the same way as other wealth and business. The 
improvement of corporate taxation would thus be but a part 
of the transformation of the ''general property tax" into a 
general tax on tangible wealth.^^ If first there is recognized 
the error of assessing the equitable ownership interests in ad- 
dition to the body of wealth, and secondly there is created an 
efficient agency of assessment, the taxation of corporations can 
be logically and easily brought into accord with a harmonious 
system; of state and local taxation. 

The assessment feature of this proposal is exemplified more 
nearly than anywhere else, though still imperfectly, in the 
''Indiana plan." By this all the wealth of the corporation 
i^ assessed as a whole, but the shares of corporations are not 
taxed in the hands of the shareholders. 

§ 16. General plan for corporate taxation. The main 
features in such a plan of reform would be as follows : 

(a) State assessment: assessment of all wealth by state 
agency, with expert non-local assessors, appointed and serv- 
ing only under the merit system. 

(b) Unit rule: the assessment of the value of each enter- 
prise and body of wealth as a unit for the whole state, and 
apportioned to the minor divisions as the basis for levying 
local taxes, 

(c) Mileage rule: apportionment of the total value in the 
state among the localities by general rule, in the ease of trans- 
portation and transmission companies, by mileage with due 
regard to the presence of local real estate and of special in- 
dustrial equipment such as repair shops and power plants. 

12 See above, § 5. 



Ch. 18] PROPERTY AND CORPORATION TAXES 303 

(d) Interstate comity: taxation of interstate enterprises 
only in due proportion to the whole business, by mileage or 
other rules ; interstate comity to be further developed in this 
matter. 

(e) Intangible factors in unit valuation: account to be 
taken, in assessment, of various factors determining the earn- 
ing power, such as good-will, patents, and other monopolistic 
elements, pertaining to and helping to determine the value 
of the tangible plant of the enterprise. 

(f) Securities not separately taxable: account to be taken 
of the market value of securities and notes owned by a cor- 
poration, in determining the taxable value of the whole busi- 
ness, but these not to be treated as a separately assessable 
"property" (in addition to the tangible plant). 

(g) Investors exempt on normal tax: exemption of the 
holders of securities and evidences of indebtedness of corpora- 
tions, though this need not prevent a supplementary system 
of graduated taxation on incomes) .^^ 

(h) Special franchises: treatment of special privileges 
granted to public-service corporations for the use of streets 
and public highways on the principle of rent-payment to the 
community rather than by levying a percentage on an assess- 
ment. 

13 See ch. 19, § 11. 

References. 

Bullock, C. J., Selected readings in public finance. Bost. Ginn. 

1920. 
Compton, W. M., Recent tendencies in the reform of forest taxation. 

J. P. E., 23: 971-979. 1915. 
Hamilton, W. H., Readings in current economic problems. Univ. 

of Chi. Press. 1914. Pp. 560, 561. 
Jorgensen, E. 0., One hundred Reasons for the Single Tax. Cliicago. 

The Chicago Single Tax Club. 1920. 
Post, L. F., The taxation of land values. Bobbs-Merrill. Indian- 
apolis. 1915. 
United States Bureau of Corporations, Report on the taxation of 

corporations. Pts. I-IV. 1909-1912. 
Young, A. N., The single tax movement in tbe United Stat€s. 

Princeton Univ. Press. 1916. 



CHAPTER 19 



PERSONAL TAXES 

§ 1. Inheritance-tax laws. § 2. Fiscal and social aspects. § 3. In- 
come taxes; general nature. § 4. Income taxation by the states. § 5. 
Obstacles to federal income taxation. § 6. Federal taxation of individ- 
ual incomes. § 7. Important features. § 8. Development and yield. 
§ 9. Corporate income and excess profits. § 10. Defective theory of 
corporate income taxation. § 11. A system of taxation. 

§ 1. Inheritance-tax laws. There remain to be consid- 
ered at least two important forms of taxation that are essen- 
tially personal in their unit of assessment, in contrast with the 
foregoing, which are (or should be, if consistent) essentially 
impersonal.^ There are the inheritance and the income taxes. 
Property received by bequest or intestate inheritance for 
taxing purposes is usually viewed as essentially income ac- 
cruing but once under peculiar conditions, and therefore 
taxable to the individual beneficiary. However, inheritance 
taxes still retain some traces of a legal origin in feudal times, 
when the estate reverted to the overlord until released upon 
the payment of certain dues, and the tax is collected in the 
course of the probating of wills under the direction of court 
officials. 

Forty-three of the American states had inheritance tax 
laws in 1921 (all but South Carolina, Florida, Alabama, 
Mississippi, and New Mexico). These laws apply generally 
to property passing either by will or under the interstate laws 
of the state. The tax is for state purposes. These laws 
differ in many ways, but are nearly all alike in certain 
respects : 

1 See ch. 18, § 3, note, and § 5, on this distinction. The poll tax also 
is personal; see ch. 17, §9. 

.304 



Ch. 19] PERSONAL TAXES 305 

(1) In applying to the separate legacies rather than to the 
estate as a whole.^ 

(2) In taxing legacies to relatives in the direct line at a 
lower rate (or even exempting them entirely) than those to 
collateral relatives.^ 

(3) In exempting legacies below a certain amount.* 

(4) In having rates progressing with the size of the legacy; 
(this feature is less general, but is prominent in most of the 
later laws). 

The federal government has until lately made little use 
of an inheritance tax. The law passed in 1862 in the midst 
of the Civil War yielded little and was soon repealed. But in 
1916 was enacted an "estate tax" (amended and increased 
in succeeding years) which is imposed upon every estate 
(as a whole, not on the several shares) on the excess over 
$50,000, at progressive rates from 1 to 25 per cent, the maxi- 
mum being on estates exceeding ten million dollars. 

§ 2. Fiscal and social aspects. The fiscal importance of 
inheritance taxes in the states has been comparatively not 
very great, but has rapidly grown. In 1903 the receipts 
from this source (in twenty-seven states) were more than 
$7,000,000; in 1913 they were (in thirty-five states) $26, 
000,000, and are doubtless now much greater. In New York 
state alone the receipts range between ten and fifteen million 
dollars a year. The yield of the federal estates tax bj'' 
fiscal years has been as follows: 

1917 $6,000,000 

1918 47,000,000 

1919 82,000.000 

1920 104,000,000 

The spread of inheritance taxes and the higher 
and progressive rates applied are an expression in part of the 

2 In Utah the tax is 5 per cent on all estates over $10,000. 

3 Exception, Utah. 

* Exceptions are Missouri, New Hampshire, Vermont, Virginia. 



306 TAEIFF AND TAXATION [Pt. Ill 

need of additional revenues and in part of the growing popu- 
lar concern regarding the concentration of wealth. Yet the 
actual legislation is something of a compromise between fiscal 
policy (to get revenues) and social policy (to reduce or to dis- 
tribute the larger fortunes. In New York legacies of more 
than $1,000,000 are now taxable at 4 per cent to relatives in 
the direct line and to all others at 8 per cent. In Washing- 
ton the tax to relatives in the direct line is from 1 to 5 per 
cent, according to the amount of the share, but to others it 
may go as high as 15 per cent. In Wisconsin, somewhat simi- 
larly, the tax may rise to 15 per cent on the excess above 
$500,000. These taxes are of considerable importance, not 
only fiscally, but as the means for reducing large inherited 
fortunes. For this latter purpose, however, it would be more 
consistent and effective to make the progressive rates apply 
to the distributive shares rather than to the estates as wholes. 

§ 3. Income taxes ; general nature. All taxes, whether 
assessed upon the capital value of goods or not, come out of 
(reduce) the incomes now or later available for individuals. 
But there are various ways of attacking incomes, i. e., of ap- 
portioning the tax burden. Income taxation is that form in 
which the basis of the assessment and levy is the income of the 
taxpayer as it arises (not accumulated wealth, or capital, or 
business processes, or expenditures). Of the various concep- 
tions of income,^ the one mainly employed in income taxation 
is monetary income arising in the course of business, supple- 
mented occasionally (but not consistently) by some items 
of material income that are expected to come to the 
person. 

There is not in the long run such a contrast between 
wealth taxation and income taxation in their ultimate 
burden and effect as is usually supposed. Indeed, wealth 
(or capital) taxation as applied to accumulated wealth 
is more far-reaching than income taxation, for it falls 
upon the present worth alike of monetary and of psychic 

5 See Vol. I, p. 26. 



Cii. 19] PERSONAL TAXES 307 

incomes (e. g., the value of a house, whetlier it is let to a 
tenant or occupied by the owner). But, on the other hand, 
income taxation attacks directly the monetary incomes from 
labor, coming as wages, salaries, fees, and profits in busi- 
ness (unfunded as distinguished from funded incomes) . 
This feature goes naturally with the fact that the income tax 
is essentially a personal tax, grouping the items of assessment 
about a person, whereas the "property" taxes are mainly 
(though not consistently) impersonal, making the piece of 
wealth the primary object of assessment. This summation of 
each person's income makes income taxation peculiarly suit- 
able for progressive taxation with the social-welfare motive 
of equalizing the distribution of wisalth. It is doubtless this 
technical assessment feature, rather than any essential ad- 
vantage as a mode of taxation, that has led to its recent 
growth in popular favor. 

§ 4. Income taxation by the states. Income taxes have 
been used widely in European countries, but until 1913 very 
little in the United States. Numerous attempts have been 
made by the states to tax incomes, but with small results. 
Personal incomes, when sought by local assessors, proved to be 
most elusive. There were (in 1913) but seven states with any- 
thing resembling a personal income tax,^ These are Virginia, 
North Carolina, South Carolina, Mississippi, Oklahoma, Mas- 
sachusetts, and Wisconsin. Of these states Wisconsin has the 
most recent law, and one the widest in its application and the 
most important fiscally. The law applies a progressive rate 
to all incomes (with exemption of $700 from wages and 
salaries) and contains elaborate provisions for corporate tax- 
ation. The proceeds are distributed 10 per cent to the state, 
20 per cent to the country, and 70 per cent to the municipality 
in which the tax is collected. In the six other states the tax 

8 In addition, certain items of receipts of companies or incomes of 
individuals are arbitrarily defined as property for purposes of taxation 
in a few cases in about fifteen other states. See Wealth, Debt, and 
Taxation, Report of the Bureau of the Census, 1907, p. 622, 



308 TAEIFF AND TAXATION ^^^ ,^. 

Ill '•'dJ 

is on incomes only exceeding a certain amount (North Caro- 
lina, $1000, the other states from $2000 to $3500 exemption) ; 
some apply to incomes from any source, but jothers do not 
apply to incomes from property otherwise taxed. The total 
receipts from these state income taxes in 1913 were but 
$314,000. 

In 1919, four states, Alabama, New Mexico, North Dakota 
and New York adopted a general income tax. In New York 
the rate is 1 per cent on incomes up to $10,000, 2 per cent on 
the next $40,000, and 3 per cent on all over $50,000. The 
yield the first year was $20,000,000. 

§ 5. Obstacles to federal income taxation. The income 
tax has now come to play a most important part in the fiscal 
system of the federal government. Until 1913, however, it 
had been used only in a small way under the law 
passed in 1861, frequently amended, and finally repealed 
in 1870, to continue in force until the year 1872. 
The rate was 3 per cent on the excess of incomes over $600, 
and 5 per cent on the excess over $10,000. This law was re- 
peatedly upheld by the United States Supreme Court as not 
in conflict with the Constitution. Its fiscal results were not 
large, as it was never effectively administered. 

The next income-tax law was that of 1894, enacted in con- 
nection with the tariff revision of that year. It was declared 
unconstitutional before it had gone into effect. The main 
ground for the decision was that a tax on incomes from rent 
of land as well as on incomes from personal property was 
direct, and must therefore, according to the Constitution, 
be apportioned among the states according to population. 

In the active discussion of social legislation in the years fol- 
lowing this decision public sentiment developed, favoring an 
amendm,ent to the Constitution. It is a remarkable fact 
that, when the bill for the sixteenth amendment to the Con- 
stitution was finally passed, it was voted unanimously by 
the Senate and almost unanimously by the House. It was 
ratified by three fourths of the states, and became a part 



Ch. 10] PERSONAL TAXES 309 

of the Constitution February 25, 1933.' The Democratic 
party, which had passed the law of 1894, was pledged to the 
passage of an income-tax law when it came into power again 
in 1913. The reduction of the tariff, as well as growing 
expenditures, moreover, made necessary the development of 
new sources of revenue for the national government. In 
other countries the income tax had been found to be a part 
of a sj'stem of taxation especially valuable as a "balance 
wheel" to equalize the revenues and expenditures. It was 
deemed by some to be an additional advantage of an income 
tax that it would make the richer citizens better realize the 
nature and burden of public expenditure. Most other federal 
revenues, being derived from the tariff and from taxes on 
merchandise, are borne mainly by the purchasers and con- 
sumers. 

An income tax was opposed as sectional taxation by many 
in the eastern states, where the owners of most of the larger 
fortunes reside. But to this Senator Elihu Root replied that 
the states where there was the greatest ownership of wealth 
pay the largest taxation under any scheme, and ought to. 

§6. Federal taxation of individual incomes. The law 
as first enacted constituted section 2 of the tariff' act of 
1913 entitled, "An act to reduce tariff duties, and to pro- 
vide revenue for the government and for other purposes." 
The development of this law, and the gi'owth of taxation 
under it as it was successively amended between 1913 and 
1919 to meet new needs, is one of the most remarkable chap- 
ters in our financial history. The law of 1913 applied both 
to individuals and to corporations. As "incomes" in these 
two cases are so different in nature, and as these two features 
in the law have had somewhat different developments, we 
may do well to treat them separately, beginning with the 
tax upon individuals. 

" Article XVI. The Congress shall have power to lay and collect 
taxes on incomes, from whatever source derived, without apportionment 
among the several states, and without regard to any census enumeration. 



310 



TARIFF AND TAXATION 



[Pt. Ill 



The law of 1913 imposed upon individuals a "normal" 
tax of 1 per cent (on the excess above exemption), and an 
''additional tax" (in later amending laws called a surtax) 
ranging from 1 to 6 per cent on individual incomes of 
larger amounts than $20,000. There were thus eight classes 
of persons: those entirely exempt; those paying only at the 
normal tax rate; and six different classes paying a surtax, 
which on the portions of income exceeding a half million 
dollars was at the maximum rate of 7 per cent. This law 
applied retroactively to the last ten months of the calendar 
year 1913 (beginning March 1), and continued to apply for 
the calendar years 1914 and 1915. The act was then succes- 
sively amended (or superseded by new laws) beginning in 
1916. These changes will be tabulated below to simplify as 
far as possible the somewhat complex details.® Let us note 
first, however, some important new features of taxation in- 
volved in this act. 

§ 7. Important features. There were various exemptions, 
$3000 on every individual income and $4000 on the aggregate 



» Income Taxes on Individuals 



Under law 
of date 



Oct. 3, 1913 



Exemption : 

Normal 
tax begins 

$3,000* 



Rate of 

normal Additional 
tax normal 

1 



Calendar 
Year 

1913 
1914 
1915 

1916 Sept. 8, 1916 $3,000» 2 

1917 Oct. 3, 1917 1,000" 2 2»> d 

1918 Feb. 24, 1919 1,000» 

1919 " " 4 4d 
1920 

Surtax attains 
maximum 

1913 $500,000 

1914 

1915 

1916 

1917 

1918 

1919 

1920 

^ And $1000 more for married person. 

»> There was here introduced, under the name of "additional normal" rate, a new 
surtax rate, applicable to all incomes of more than $3000 for single persons and 
$4000 for married persons. 

<^ This act provided that the normal rate and additional normal rate should be 
6 per cent in the calendar year 1918 and 4 per cent thereafter. 

* The additional normal rate began at $3000, whereas the normal rate began at 
$1000 (for ;i married person the exemption was $1000 more). 



$2,000,000 
2,000,000 
1,000,000 



Surtax 
rates 
1-6 



1-13 
1-63 
1-65 



2 
2 

ee 

4 

Number 

of returns 

357,598 

357,515 

336,652 

437,036 

3,472,890 

4,425,114 



Surtax 
begins 

$20,000 



20,000 
5,000 
5,000 



Amount 

collected 

$28,300,000 

41,000,000 

67,900,000 

173,400,000 

675,200.000 

1,127,700.000 



Ch. 19] PERSONAL TAXES 311 

income of husband and wife living together (this distincton, 
it will be observed, offers a reward of $20 per annum to make 
marriage a failure). Among allowable deductions are sums 
paid for taxes (except assessments for local benefits), 
necessary business expenses, losses sustained, and (for the 
normal tax only) those parts of individual incomes derived 
from corporations that have paid the tax on them. 

The difficulty of getting an honest and complete assessment 
of incomes is great. All taxation is deemed by the taxpayer 
to be "inquisitorial" in some degree, and this is particularly 
true of an income tax. In England had been developed the 
plan called "stoppage at source," by which corporations and 
other businesses were required to deduct taxes before paying 
dividends, salaries, etc., to taxable persons. The taxation of 
corporations at the rate of the normal tax, while requiring 
them to report the names of those receiving dividends and 
interest payments, gave an ingenious way in our law of 
checking up the returns of individuals in respect to a olass 
of investments that is steadily increasing in importance. By 
amendment, stoppage-at-souree was in many cases changed 
to the requirement of reporting-at-source, as less troublesome 
and equally efficient. 

The most disputed feature of the income tax probably was 
the principle of graduation, called also progression. It is up- 
held in part because in this case it but offsets regression, that 
is, relatively heavier taxation on the smaller incomes, in the 
case of the other kinds of taxes (tariff, property taxes, etc.). 
It is urged further that those of larger incomes, especially the 
largest, have marked advantages over others in making in- 
vestments. Further it is urged that the higher the income the 
less does a certain rate cut into the "amount necessary for 
good living" (as was said in Congressional debate). This is 
in accord with the psychological principles of choice, of value, 
and of diminishing gratification. Finally, there is a wide- 
spread approval of the progressive rate just because it in so 
far acts as a leveling influence upon fortunes. The "addi- 



312 TARIFF AND TAXATION [Pt. Ill 

tional" tax is already important fiscally, yielding more than 
one half of the total paid by individuals and one fourth of 
the total from corporations and individuals. 

§ 8. Development and yield. The income tax was made 
retroactive to include incomes accruing from March 1, 1913, 
to the end of the year, and continued to apply to December 31, 

1915, and the personal income tax yielded approximately 
$28,000,000 in the ten months of 1913, $41,000,000 in 1914, 
and $68,000,000 in 1915. In September, 1916, the law was 
changed by doubling the normal rate and increasing the sur- 
tax rates to a maximum of 13 per cent. This law also was 
applied retroactively to incomes accruing from January 1, 

1916, and continued in force during the calendar year 1916, 
yielding more than $173,000,000. 

After our entry into the war was passed the act of October 
3, 1917, called the War Revenue Act, reducing the normal ex- 
emption from $3000 to $1000 ($4000 to $2000 in case of mar- 
ried persons living together), imposing under the name of an 
*' additional normal tax" a new surtax of 2 per cent on all in- 
comes of more than $3000 for single persons and $4000 for 
married persons, increasing the surtax maximum rate to 63 
per cent and reducing to $5000 (taxable income) the point at 
which it began. The number of returns (that is, taxable per- 
sons) was thereby increased to nearly three and one half 
millions, and the yield of the calendar year 1917 was more 
than $675,000,000. 

The war tax legislation of February 24, 1919, attempted to 
meet the financial needs of the government when they were 
at the maximum. The principal changes in the individual 
income-tax law were in the normal and the additional normal 
rates, both being trebled to apply retroactively to incomes 
in the calendar year 1918, -and the increase of the surtax 
by rearranging the classes and applying the maximum 
rate of 65 per cent to all incomes of more than $1,000,000 
(half the amount previously paying the maximum). Under 
this act there were nearly four and one half million tax- 



Ch. 19] PERSONAL TAXES 313 

able persons, and the yield for the calendar year 1918 was 
$1,128,000,000. The act provided for the reduction of the 
normal rates (regular and "additional") each from 6 to 4 per 
cent for the calendar years 1919 and 1920. 

§ 9. Corporate income and excess profits. Along with the 
federal taxation of individuals under the income tax has since 
1913 been closely linked a new and special form of taxation 
of corporations. Important legislative changes in the one 
have been nearly always accompanied by equally important 
changes in the other. 

Before the adoption of the sixteenth amendment, the need 
for new revenue in the Taft adminstration led to the en- 
actment, August 5, 1909, of an "excise tax" on corporations, 
measured by net profits within the taxing period. This 
3'ielded in the four years that it was in force an average of 
about $32,000,000 annually. 

This excise-tax feature was abandoned in 1913, or it may be 
better to say that it was incorporated into the income-tax law 
of that year, by which net corporate profits ("incomes") 
were made subject to a normal rate of 1 per cent, as were 
those of individuals. This yielded between 1914 and 1916, 
between $30,000,000 and $60,000,000 a year. In 1916 this 
normal rate was increased to 2 per cent, at which the yield in- 
creased to $180,000,000 in the fiscal year 1917. At the same 
time a tax of 121/4 per cent was laid upon net iiicomes de- 
rived from the manufacture of munitions (a business then 
most prosperous through enormous sales to the Allies) ; and 
the capital stock of certain large classes of corporations was 
subjected to a tax of 50 cents (soon doubled) on each $1000 
par value in excess of $99,000. These various taxes on cor- 
porations in the aggregate were capable of yielding nearly a 
quarter billion dollars. But this was only the beginning of 
corporation taxation. While continuing the normal income 
rates on corporations, the law of March 3, 1917, laid the first 
excess profits tax (8 per cent on corporate profits exceeding 
8 per cent of actual capital invested) ; but this law 



314 TARIFF AND TAXATION [Pt. Ill 

was superseded by the War Eevenue Act of October 
3, 1917, which levied war excess profits taxes upon 
incomes alike of individuals, partnerships, and corpora- 
tions. The details are too complicated for discussion 
here, but a few features may be noted. A distinction was 
drawn between incomes derived chiefly from personal or pro- 
fessional service (taxed at a flat rate of 8 per cent, after the 
exemptions) and incomes derived primarily from invested cap- 
ital (taxed at progressive rates in accordance with the per- 
centage that profits bore to ' ' invested capital ' ' value) . In the 
case of the latter the lowest rate, 20 per cent of profits, was 
applied on "net income" not in excess of 15 per cent of the 
invested capital; and the highest rate, 60 per cent on "net 
income" in excess of 33 per cent of invested capital. The 
amount of income exempted was $3000 for corporations and 
$6000 for partnerships and individuals, and also, in all cases, 
an amount of new income equal to a specified percentage of 
the invested capital during the "pre-war period," defined 
as the years 1911, 1912, and 1913, The yield from this tax 
was enormous, the total from corporate incomes and excess 
profits (mostly the .latter) in the calendar year 1917 being 
nearly $3,000,000,000 and in 1918 more than $4,000,000,000. 
§ 10. Defective theory of corporate income taxation. 
There is apparent in all this legislation the attempt to treat 
corporations and individuals on the same principles, especi- 
ally in applying to both of them alike exemptions and pro- 
gressive rates. There is much confusion of thought here, for 
(1) "income taxes on individuals" and (2) "income and ex- 
cess profits taxes on corporations ' ' are very different in their 
nature and their sources. The term "net income" as applied 
to individuals is charged with psychological meaning. The 
whole modern theory and justification of progressive rates as 
applied to income taxation assumes that the income on which 
the rates are imposed is a total of the various income items 
(real and monetary) of an individual. His net income 
within the year is available for spending and enjoyment, or 



Ch. 19] PERSONAL TAXES 315 

to add to his capital as a net addition. If this net income 
total is small, it should not be taxed at all, for that would 
take away part of what is conceded to be necessary for the 
minimum of comfort. Hence, exemptions are granted not 
only to the poorer citizen, but to all citizens, for even the 
richer taxpayer should not be taxed on that portion of his 
income necessary to existence or minimum comfort. Hence, 
also, progressive rates on larger incom"es, since the sacrifice, 
the psychic cost, of giving up the marginal portion of in- 
comes is assumed to become progressively less to the indi- 
vidual as his income increases. The second reason for pro- 
gressive taxes, namely, the social benefit of leveling somewhat 
the larger fortunes, is likewise applicable only to individuals, 
or at most to large corporations owned by one or by few 
men. 

In truth, the concept of income is not applicable at all 
to corporations without confusion of thought. Only indi- 
viduals have net incomes, enjoyable or available for rein- 
vestment. Corporations have receipts and expenditures, have 
net profits (or losses), at the end of the year, the equitable 
title to which belongs to various individuals, as evidenced 
by the securities they hold. But a moderately small cor- 
poration may. have virtually but one owner, and he very rich, 
whereas an extremely large corporation may have many par- 
tial owners, most of them with very modest incomes. Ex- 
emptions and progressive rates, varying in accordance with 
the total of the profits ("income") of corporations, have 
therefore no relationship in principle to those in the case 
of individuals. 

Nor can taxation of corporate profits at progressive rates 
in accordance with the ratio of profits to invested capital 
be justified on the same grounds as progressive income taxa- 
tion. "Invested capital" is a term that in practical busi- 
ness has a wide range of meanings, and the excess profits tax, 
when first imposed, caught the corporations with the most 
varied book values of capitalization. In general, the more 



316 TAEIFF AND TAXATION [Pt. Ill 

recklessly they have been financed and the .larger the amount 
of watered stock they had issued, the smaller the rate of 
profits on which they were taxable, and vice versa. The im- 
perative necessities of war finance may relatively justify any 
measure of taxation that produces the results immediately 
desired; but the fundamental defects soon produce grave 
abuses and widespread protests, and will compel revision of 
our federal corporate taxation. The income tax is here as a 
permanent feature of our tax system. Eventually it should 
be reconstructed on the sound principle that only individuals 
have incomes. In various ways increments in capital value 
and undistributed profits of partnerships and corporations 
might be periodically assessed as income to the individual 
owners, thus verging into one simple whole the many diverse 
elements in our present complex of income and excess-profits 
taxation. 

§ 11. A system of taxation. The task of reforming and 
developing the various kinds of taxes and of uniting them 
into a just and consistent plan for each of the divisions of 
government in the United States is a vast and difficult one. 
There are many conflicting interests among states, between 
states and nation, among the various minor political divisions, 
and among individuals and classes. There are also conflicting 
opinions regarding many features of the possible practical 
plans. Because of these it is safe to predict that progress will 
not be made quickly, steadily, nor always directed toward a 
clear ideal. If progress is to be rapid, the public must, how- 
ever, have consistent principles by which its steps may be 
guided. In the foregoing kinds of taxation are the various 
elements that may be united into a system of taxation. It 
is useful to consider how this might be done. 

At the basis of the whole tax structure is taxation, by value, 
of concrete wealth at the place where it is situated {in 
situ). This should be regardless of the distribution of owner- 
ship or of the residence of the owner. The present misnamed 
' * general property tax ' ' already presents the main outlines of 



Ch. 19] PERSONAL TAXES 317 

this form of taxation, and the general changes necessary in law 
and method of assessment have been indicated above.^ Cor- 
poration taxation may be adjusted to this either by separate 
treatment and assignment to state purposes only, or more sim- 
ply for most states, by assimilating it with the general taxa- 
tion of wealth and allotting due shares of the proceeds to the 
various taxing divisions.^° The national government can, be- 
cause of its exclusive power of levying tariff duties and also 
because of its exclusive control over interstate commerce, reach 
the tax-paying ability of the nation effectively by a combina- 
tion of tariff and internal duties levied upon business acts. 
These mostly become merged into business costs, and are 
diffused over the whole population through general prices.^^ 

This system of impersonal wealth taxation may then be 
supplemented by personal taxation, applied through inherit- 
ance and income taxes. These forms of taxation extend over 
and reach many of the same persons and incomes as do ulti- 
mately the impersonal taxes. But the summation of personal 
incomes gives the necessary condition for applying the prin- 
ciple of progression as far as this is, by public opinion, deemed 
desirable either for fiscal or for social reasons. 

9 See above, ch. 18, § 5. 

10 See ch. 18, § 15, and § 16. 

11 See ch. 16, § 12 and § 14, first paragraph. 

References. 

Bullock, G. J., Selected readings in public finance. Bost. Ginn. 

1920. Chs. XII, XVI. 
Daniels, W. M., The elements of public finance. N. Y. Holt. 1904. 

Pt. II, ch. VIII. 
Hill, J. A., The income tax of 1913. Q. J. E., 28: 46-68. 1913- 

1914. 
Seligman, E. R. A., The income tax. N. Y. Macmillan. 1914. 
West, Max, The inheritance tax. 2d ed., N. Y. Longmans. 1908. 



PART IV 
WAGES AND LABOR 



CHAPTER 20 



METHODS OF INDUSTRIAL REMUNERATION 

§ 1. Workers subordinate in early societies. § 2. Workers in the Mid- 
dle Ages. § 3. Growth of the wage system. § 4. Pros and cons of the 
wage system. § 5. Time work. § 6. Task work. § 7. Piece work. 
§ 8. Premium plans. § 9. Aim of profit-sharing. § 10. Examples of 
profit-sharing. § 11. Difficulties in profit-sharing- § 12. Defective the- 
ory of profit-sharing. § 13. Purpose of producers' cooperation. § 14. 
Limited success of producers, cooperation. § 15. Its main difficulty. 

§ 1. Workers subordinate in early societies. As far back 
as the history of settled and populous communities can be 
traced, the masses of workers have been subordinate. Civili- 
zation began with direction, with obedience to superiors on 
the part of the mass of men. Even in the rudest tribes, the 
women and children were subject to the will of the stronger, 
the head of the family. Among the Aryan races the family 
system was widened, and the patriarch of the tribe secured 
personal obedience and economic services from all members of 
the community. Chattel slavery, the typical form of indus- 
trial organization in early tropical civilization, seems to have 
been one of the necessary steps to progress from rude condi- 
tions; students to-day incline to view it as an essential stage 
in the history of the race. But, as conditions changed with in- 
dustrial development, chattel slavery became an inefficient 
form of industrial organization and a hindrance to progress. 
Slavery in the southern states of the American union was 
long a modern exception. The combination of racial differ- 
ence between subject and master people, of warm climate, of 
special agricultural crops and of conditions in which slave 
labor could be employed with least disadvantage, combined to 

321 



322 WAGES AND LABOR [Pt. IV 

delay the disappearance of slavery from a community in 
which the life of the master people was in many respects 
on the highest plane of civilization. 

§ 2. Workers in the Middle Ages. Serfdom for rural 
labor and many limitations of workman's freedom in the 
towns were the prevailing conditions in medieval Europe. 
Serfdom was both a political and an economic relation. The 
serf was bound to the soil; the lord could command and con- 
trol him; but the serf's obligations were pretty well defined. 
He had to give services, but in return for them he got some- 
thing definite in the form of protection and the use of land. 
Between the lord and the serf there continued an implied 
contract, which passed by inheritance from father to son, in 
the case both of the master and of the serf. In the towns 
conditions were better for the free master class of the artisans 
who owned their tools and often a little shop where they both 
made and sold their products. But the mass of the workers, 
shut out from special privileges, bore a heavy burden. There 
were strict rules of apprenticeship; gild regulations forbid- 
ding the free choice of a trade or a residence; laws against 
migration into the town; settlement laws making it impos- 
sible for poor men to remove from one place to another; ar- 
bitrary regulation of wages, either by the gilds in the towns 
or by national councils and parliaments, forbidding the work- 
men to take the competitive wages that economic conditions 
would have forced the employers to pay; combination laws 
forbidding laborers to combine in their own interest. These 
conditions prevailed even in the periods and in the countries 
often referred to as particularly favorable for the working 
classes (such as England in the fifteenth century). 

§ 3. Growth of the wage system. Throughout the Middle 
Ages these conditions were gradually changing, and the 
changes were hastened by the discovery of America, by the 
social unrest accompanying the Reformation, and by other 
forces. Servile dues in the rural districts were, in England, 
by the sixteenth century, commuted for cash payments, and 



Ch. 20] METHODS OF INDUSTEIAL RENUMERATION 323 

had begun to disappear in the other western countries of 
Europe. The agricultural work was done partly by the 
peasant landowners, partly by yeomen farmers on their own 
land, and partly by laborers hired by landowners or by tenant 
farmers (enterprisers with some capital for equipment). The 
growth of commerce and of the mechanical trades in the 
towns required larger ships, factories, and shops, and increas- 
ing investments. This required in the towns an increasing 
proportion of hired laborers having little or no capital in- 
vested in industry, and living on wages. This change went,-^ 
on more and more rapidly with the introduction of machinery 
in the eighteenth and nineteenth centuries, and ''the wage 
system" grew steadily to be a more and more important part 
of the whole economic structure.^ 

§ 4. Pros and cons of the wage system. The wage system 
has certain practical merits of workableness which account 
for its progress and dominance. It keeps alive competitive 7 
motives among the wage workers to improve and advance by 
skill and industry; it brings the planning and management 
of business into the hands, in the main, of the provident and 
capable.^ Under the wage contract, the employer, as the 
one best prepared to do it, takes the risk as to the future sell- 
ing price of the produce ; the worker receives in a definite sum 
at once the market value of his services. This is of growing 
importance, for the larger the market and the longer the wait- 
ing period in industry, the greater the element of uncer- 
tainty and financial risk. Wage payment, therefore, is a 
form of insurance to the workingman; he gets something 
definite instead of taking chances he is ill prepared to take. 
Wage payment is a form of credit to the laborer whose labor 
is applied to producing the goods for customers distant in 
time and in place. The employer advances to the workman — 
the present value of his labor, embodied in a product for 
future sale, discounted at the prevailing rate. J 

iSee Vol. I, pp. 227, 318, 322. 

2 See Vol. I, p. 329, on selection of managed and managers. 



324 WiAGES AND LABOR [Pt. IV 

But the wage system has brought with it grave problems 
of inequality of incomes and of opportunity that at times 
■ threaten the very existence of democratic society. It means 
for the mass of men continuance throughout life in the posi- 
tion of hired workers, with no possibility of becoming self- 
directing enterprisers. In connection with increasing division 
of labor, it means for great numbers unvarying application 
to one narrow task, with little imderstanding of its relation 
to the whole and with less joy in workmanship than the old 
independent handicraftsmen had. Yet is it correct to say 
that the wage system causes these inequalities in ability 
and in variety and agreeableness of tasks? Is it not rather 
itself the result of the differences of ability, a way found 
through society's long experience by which individuals may 
choose their occupations within the range of their abilities 
to gratify the desires of consumers, a way of attaining a high 
degree of efficiency in production ? ^ The problem for a wise 
political economy to solve is, and will be, to retain the best 
in the wage system, while remedying its evils or reducing 
them to a minimum. 

§ 5. Time work. Wage payment implies a contract by 
which the employee on his part agrees to render service and 
the employer on his part agrees to pay for it. The methods 
of determining and measuring the amount of service of 
the employee are called "methods of industrial remunera- 
tion.'! The many varieties may be grouped in two classes, 
time payment and piece payment, corresponding with the 
two modes of measuring labor, time work and piece 
work. Time work came first and was long almost the 
only method. In time work the employee is paid by the 
hour, day, week, month, or year, as the case may be. This 
is very satisfactory for small enterprises, where the master 
works with his own hands alongside of the employee, oversee- 

3 See Vol. I, chs. 16-19. 



Ch. 20] aiETHODS OF INDUSTRIAL REIMUNERATION 325 

ing him, teaching him, and stimulating him by his own pres- 
ence and example of industry. This method prevails still in 
nearly all farming work, in many kinds of manufacturing, in 
most transportation, in clerical positions in trade, and in gen- 
eral where the employee must perform a variety of tasks. 

Considering a brief period, it might seem that in time work 
the worker is paid by time regardless of his effort or per- 
formance. However, in every industry there is a recognized, 
fairly definite standard of accomplishment for those getting 
the regular market rates of wages, so that the time standard 
implies some performance or piece standard also. But this 
is judged by the employer only in a general way, and very 
commonly men of different degrees of efficiency continue for 
some time to receive the same money wage. Still, where any 
differences become noticeable to the employer in quantity of 
work, quality of work, or personal qualities of honesty, reli- 
ability, and good temper, the better workman is likely to 
obtain a better position, higher pay, more regular employ- 
ment, or some other form of reward. The employer is more 
likely, at the end of any period of employment, to discharge- 
the man who falls short either in quantity or quality of work, 
and to retain and advance the better worker. The method of 
time payment does not directly tempt the workman to slight 
the quality of his work by haste. It does not keep constantly 
before the worker the thought of his own interest in rapid 
work, often with an accompanying nervous and mental strain. 
In most occupations, therefore, the workers prefer time work. 
In does not take exclusive account of the quantity of material 
product, but leaves place for estimating various personal 
qualities of the employee which are of value in a business. - 

§ 6. Task work. There are thus both advantages and dis- 
advantages in time work, and their relative importance varies 
in different industries and industrial conditions. Especially 
is the difficulty of supervising workers and of insuring the 
performance of a certain standard, or minimum, amount and 



326 WIAGES AND LABOR [Pt. IV 

quality of work great in larger enterprises. Various methods 
of measuring the performance of the worker directly by some 
other than the time standard have been developed. All of 
these, in some measure, involve the piece-work principle. 

Task work, also called "doing a stint," is nominally time 
work, with a penalty if a certain amount of product is not 
turned out within a given period. The agreement may be 
that, if the specified task is not done within the regular time, 
it must be completed in overtime without additional pay. 
This method has been extensively used in the ready-made 
clothing business in America, and is to some extent involved 
in many cases of wage payment in manufacturing. 

§ 7. Piece work. Piece work of the simpler or ordinary 
kind is that where the payment varies according to the 
amount of the product, by some physical measurement, as 
yards of cloth woven, number of pieces turned on a lathe, or 
amount of type set by a printer. Usually careful inspection 
by some agent of the employer serves to keep the quality up 
to a certain standard. The rejected pieces are not paid for, 
and sometimes also the workmen are required to pay for the 
materials wasted by their poor work. Piece payment is con- 
venient for home work, such as that of rural peasants weaving 
cloth for commission merchants or as that of tenement workers 
in cities. It is also employed very widely in the larger fac- 
tories in textile and mechanical industries. Selling on com- 
mission is a form of piece work. 

In piece work the motive to activity is ever present to the 
worker, and generally the worker turns out a larger 
product when paid by the piece than when paid by time. The 
employer benefits by the more efficient use of his machinery 
aiid_equipment, even when the price per piece is not reduced" 
with the larger output per worker. The worker's earnings 
may increase rapidly under this plan ; but as the manual dex- 
terity acquired is usually of a very special kind which can be 
used only on one particular machine, the worker has little 
opportunity to resist a cut in his wages. For this reason and 



Ch. 20] METHODS OF INDUSTRIAL REMUNERATION 327 

because of the undue strain upon the worker that often occurs, 
piece work is in many trades not favored l\v tlie workers.* 

§ 8. Premium plans. Various modifications of piece work 
have been developed of late, all involving the features of a 
minimum task and of a premium for performance beyond 
that point. These plans are called "premium plans," "pro- 
gressive wage systems, ' ' and ' ' gain sharing. ' ' One of the 
first of these, Halsey's premium plan, fixes a standard time 
for a job, and if the worker falls short of, or merely 
attains to, that standard he gets the regular pay; but 
if he takes dess than the standard time he receives a 
fixed premium per hour equal to one third of the wage 
for the time saved. For example, if the standard time is 10 
hours for a $3 job the premium for speed is ten cents per 
hour, and the worker would receive 20 cents premium if he 
did the work in 8 hours ($2.40 + 20, total $2.60), and 50 
cents premium if he did it in 5 hours ($1.50 -|- 50, total 
$2.00). His average wage per hour thus rises as his speed 
increases ; it becomes 32.5 cents per hour when the job is done 
in 8 hours, and 40 cents per hour when the job is done in 5 
hours. The reduction of cost per job to the employer evi- 
dently would be 40 cents in the first case and $1 in the 
second. This is Halsey's plan, by which the worker gets one- 
third and the employer two-thirds of the time saved. 

The same plan has been applied (Weir's method) with a 
premium that equally divides between the workman and the 
employer the time saved. By Rov\'an's method the premium 
is not a fixed sum but a percentage of the standard rate per 
hour equal to the percentage of reduction in time consumed. 
If in the foregoing example the time were reduced 20 per 
cent (to 8 hours) the premium would be 20 per cent of 30 
cents, and the workman would receive 36 cents per hour. 
By this plan the premium is larger for the earlier reduc- 
tions in time and becomes less for the later reductions than 
in either of the other plans. 
4 See ch. 21, § 6. 



V 



Time to 
complete 
job 


Number 
of hours 
saved 


Halsey 
plan, fixed 
per hour, 
10 cts. 


Weir plan, 
saving div- 
ided equal- 
ly 


10 











9 


1 


.10 


.15 


8 


2 


.20 


.30 


7 


3 


.30 


.45 


6 


4 


.40 


.60 


5 


5 


.50 


.75 


4 


6 


.60 


.90 


3 


7 


.70 


1.05 


2 


8 


.80 


1.20 


1 


9 


.90 


1.35 



328 WAGES AND LABOR [Pt. IV 

Examples Where Standaed Time is 10 Hours, at $3, 
Standard Pay Pee Hour 30 Cents 

Premium for the job by 

Eovran plan, 
hourly premium 
equals percentage 
of reduction 



.27 
.48 
.63 
.72 
.75 
.72 
.63 
.48 
.27 

By Halsey 's plan the employer gets two thirds of the 
total saving- in time, by Weir's plan one half, and by Rowan's 
a percentage varying directly in the ratio of the time saved. 

A number of other variations have been worked out by the 
promoters of recent scientific management, notable ones be- 
ing Taylor's, Gantt's, and Emerson's plans. The authors of 
all these plans agree as to the importance of fixing the 
standard rate so that it will leave a possibility of consider- 
able improvement with unusual effort, and of leaving the 
standard rate and premium unchanged as long as no new 
process or new machinery is introduced into the business. 
If this is not done the employees lose faith in the plan and 
refuse to make the necessary effort to earn the premium. 
Most of these plans of payment recently have been connected 
with experiments and studies in scientific management to re- 
duce the time and increase the ease of the operations. 

In a variety of ways a bonus or a premium may be paid for 
quality, or for economy in the use of materials (as to a fire- 
man for using less coal), or for various other results. Every 
business has its peculiar conditions that make certain results 
especially desirable and certain methods of reward prac- 



Ch. 20] METHODS OF, INDUSTRIAL REIMUNERATION 329 

ticable. In some industries, for example, the various plans 
of piece work and of premium pa^^ment are applied to groups 
of workers (as in collective piece work), the total payment 
being then divided among the members of the group in some 
agreed proportion. 

§ 9. Aim of profit-sharing. Profit-sharing is rewarding 
the laborer with a share of the profits in addition to his usual 
contract wages. Payments by the piece and premiums for 
output are solely dependent on the efforts of the particular 
workman (or collective group), but in the plan of profit- 
sharing a premium is given in addition to the regular wage 
if, at the end of the year, the business as a whole has yielded 
a profit above a certain amount. Profit-sharing is not merely 
a gift; it is done usually in accordance with a definite 
promise in advance. The employer adopting the plan does 
not intend to lose by it. His purpose is to stimulate the in- 
dustry of the workers, thus reducing waste and cost of labor 
and supervision, and thereby increasing profits. He offers 
to divide with the workman the additional profits that are 
expected to result from their efforts. There is, in every fac- 
tory, greater or less waste of materials, destruction of tools, 
and loss of time, that no rules or penalties can prevent. If 
the worker can be made to take a strong enough personal in- 
terest, he will use care when the eye of the foreman is not 
upon him. The product also can be slightly increased in 
many ways by the workman's exertions or suggestions. In 
some cases the quality of the work cannot be insured by the 
closest inspection as well as it can be by a small degree of 
the worker's interest. Either responsibility for the fault can- 
not be fixed, or the defect is one not measurable by any easily 
applied standard. Strikes may be averted, good feeling pro- 
moted, and contentment furthered if the interest of the 
worker can be made to approach, and in large measure to 
become in harmony with, that of the employer. The eco- 
nomic result of the plan, if it can be made to work, should 
be to reduce the costs of these establishments below what they 



330 WAGES AND LABOR [Pt. IV 

are. The crucial question is whether profit-sharing alone in 
any particular case will insure that the costs will be less than 
those of competitors, thus giving a source out of which an 
increased amount, really a wage, can be paid to the laborer. 
J'or the amount of profits is affected not only by the amount 
of output, but also by a number of other things that are quite 
outside the control of the workmen. 

§ 10. Examples of profit-sharing. The profit-sharing 
plan seems first to have been successfully tried in Paris, in 
1842, by Leclaire, a house-painter. In house-painting there 
is often a great waste of materials and time by men working 
singly or in small groups in different parts of the city. By 
this new method Leclaire enlisted the aid of the workmen, 
reduced the costs, and increased the profits. It is a remark- 
able fact that the plan has been continued successfully by the 
same firm to the present time. It has been tried in many hun- 
dreds, possibly thousands, of cases, and is operating in some 
form or other, in more than a hundred firms in Europe and 
America. The most notable examples of profit-sharing in the 
United States are the Pillsbury Mills in Minnneapolis, Procter 
and Gamble's soap-factories in Ivorydale, Ohio, the Nelson 
Manufacturing Company in Leclaire, 111., and the Ford Auto- 
mobile "Works in Detroit. In some cases both manufacturer 
and workmen value the system highly. It probably has its 
greatest success when applied in prosperous establishments 
where profits are regular and large, and where a steady work- 
ing force is especially desired. The proportion of business 
done in this way is not large. One hundred firms is a very 
small fraction of 1 per cent of the total number of firms in 
Germany, France, England, and America. A still more impor- 
tant fact is that true profit-sharing has spread little since 
1890, though various practices have developed under that 
name. The most noteworthy of these is the selling of stock, 
usually at a somewhat lower price, to the employees of a cor- 
poration, so that, as stockholders, they may have a motive to 
work for the success of the company (e. g., the United States 



Cir. 20] METHODS OF INDUSTRIAL REMUNERATION 331 

Steel Corporation). This method as applied to a select few 
of the employees, who are advanced to official positions in a 
corporation, is very widely adopted. 

§ 11. Difficulties in profit-sharing. Many have found it 
hard to credit the evidence of this comparative failure of a 
plan that looks so attractive in spirit and for which so much 
was hoped. Yet objections come from the side both of the 
workman and of the employer. The workman lacks the — 
knowledge of the business and is suspicious of the book- 
keeping. If at the end of the year the books show no 
profits, the workman loses confidence, considers the plan to 
be mere deception, and rejects it. The working of the 
plan remains in the employer's hands, and the work- 
man really is not a partner in the business. Moreover, the 
plan puts a limitation upon the workman's freedom to 
compete for better wages by changing his place of work. It 
is indispensable to make length of service in some degree a 
condition to the sharing of profits. Workmen, coming and 
going, cannot be allowed to share; the percentage given to 
the others increases with length of employment. Whenever 
men are thus practically subject to a fine (equal to the amount 
of shared profits) if they accept a better position, there is 
danger of a covert lowering of wages. The plan tends to 
break up the trade-unions, which is one of the reasons that 
the employers like it and is the main reason that organized i 
labor opposes it. 

The employer, on his part, objects to the interference with 
his management, the troublesome inspection of the books, and 
the constant complaints of the workmen. He dislikes to 
have the profits known; if they are large, the advertisement 
of success invites competition ; if they are small, publicity may 
injure credit and depress the value of the enterprise. In 
view of all these difficulties, it is not surprising that, while the 
plan often starts promisingly, it usually fails after a short 
trial. Business methods are severely subject to the principle 
of the survival of the fittest. Through competition and the 



332 WiAGES AND LABOR [Pt. IV 

survival of the firms that adopt improvements, better methods 
must eventually supplant poorer ones. If a method fails to 
spread when it has been tried for seventy-five years and all 
are free to adopt it, the strong probability is that it has serious 
defects inherent in it. 

. § 12. Defective theory of profit-sharing. It is usually 
better to make wages depend on the worker's efficiency rather 
than on the profits of the whole business. The strongest 
motive to efficiency is present when reward is connected im- 
mediately and directly with effort, not with some result only 
slightly under the worker's control. Any change in the 
amount of profits is only partially and indirectly related to 
increased effort of the worker. The ' 'profits" may be nothing, 
though all the manual workers may be exerting themselves to 
the utmost. The wage bill is but one of the group of costs. 
^Profits are the net result of many influences, and chief among 
these is the skill in planning and conducting the business. 
This function of management is either performed by the same 
person who is carrying the financial risk, or by some salaried 
. employee selected by him. It is this management function 
the reward of which should, in theory, be made to vary with 
the amount of profits; and in fact such an arrangement 
(managerial profit-sharing, so to speak) is undoubtedly in 
operation in thousands of cases, but is not included in the usual 
conception of profit-sharing. Many salaried managers are in 
receipt of a share of profits and are gradually acquiring an 
interest in partnerships or a larger share of ownership in the 
enterprises for which they work. But ordinary profit-sharing 
is not in accord with the general trend toward the centraliza- 
tion of responsibility in the hands of competent managers, in- 
suring to the worker a definite amount in advance, as high as 
conditions make possible. The system of premiums, or bonus 
payments, for output, where it can be safeguarded against 
abuses, gives in most eases better results and is rapidly 
spreading. It is sounder in conception and works better in 
practice as a method of remuneration for most of the workers. 



Ch. 20] METHODS OF INDUSTRIAL REMUNERATION 333 

Likewise the pretty general participation in ownership of 
stock by the employees of a corporation may exert an in- 
fluence distinctly steadying upon labor conditions in the in- 
dustry, and may increase the personal interest of the workers 
in the efficiency of the factory operations. It may, in the 
plan of partial payments, help to develop a spirit of thrift 
in the employees, a result beneficial alike to them, to the 
corporation, and to the civic community in which they live. 
But this is not truly profit-sharing; and wage-earners gener- 
all}' should be encouraged to invest in government and cor- 
poration bonds of a conservative sort rather than in the 
common stock of a manufacturing corporation. 

§ 13. Purpose of producers' cooperation. Since the early 
part of the nineteenth century many well-wishers of humanity 
have cherished high hopes that the whole wage system might 
gradually be replaced by the plan of producers' cooperation 
among workingmen. Producers' cooperation is the union of 
workers in a self -employing group, performing for themselves 
the enterpriser's function. The workers hope to get what 
seems to them to be a needless drain of profits into the pockets 
of the employer and unnecessarily high salaries to managers. 
To do this they must perform the enterpriser's function as to 
investment and risk. Collectively or through their represen- 
tatives, they must undertake to furnish capital and manage- 
ment as well as hand-work. The capital may be supplied 
either by the members, individually or collectively, or may 
be borrowed from outsiders, who are thus merely passive in- 
vestors. Usually the return to capital invested by members is 
limited to 5 or 6 per cent, so that thii part of the capital 
likewise is treated as a passive investment, and all the real 
variable profits are distributed to the members as wages. 
The hope has been, as in profit-sharing, to increase the amount 
of profits through the stimulus the plan might give to the 
workers and by saving in friction, disputes, and strikes. 

§ 14. Limited success of producers' cooperation. Practi- 
cally, the plan has been made to work in a comparatively 



334 WAGES AND LABOR [Pt. IV 

few simple industries. A much cited example of successful 
cooperation in America is that in the cooper-shops in Minne- 
apolis. There were few and uniform materials, patterns, and 
qualities of product, few machines and much hand-labor, 
simple well-known processes, a simple problem of costs, a sure 
local market. At its largest development the enterprise was 
small compared with the typical manufacturing enterprises 
in America. After more than thirty years the main shop, 
when visited by the writer, was still in operation, but with a 
membership of the older men and with no growth. A number 
of the less skilled workers received ordinary wages, and there 
had recently been labor troubles of quite an ordinary 
kind. 

^* In America a few of the productive cooperative companies 
are found operating small factories. In England there have 
been numerous successful societies, but all in small enterprises, 
mostly connected with agriculture. Within the whole field 
of industry, this method of organization makes little if any 
progress. Most experiments have failed, and the successful 
ones have become or are tending to become ordinary stock 
companies with most of the stock in the hands of a few men. 
Therefore, whether losing or making money, they nearly all 
cease to exist as cooperative enterprises. This result has dis- 
appointed the hopes and prophecies of many well-wishers of 
the working-classes. 

^ § 15. Its main difficulty. The main difficulty in producers' 
cooperation is to get and retain managerial ability of a high 
order. Failure to do this results in inability to maintain and 
Keep in repair the equipment and to pay the ordinary returns 
to the passive investment, and financial failure follows. 
There is no touchstone for business talent, no way of selecting 
it with any certainty in advance of trial. This selection is 
made hard in cooperative shops by jealousies and rivalries, 
and by politics among the workmen. A man selected by his 
fellows finds it difficult to enforce discipline. In cooperation 
there is occasionally developed good business ability that might 



Ch. 20] METHODS OP INDUSTRIAL REMUNERATION 335 

have remained dormant under the wage system; some work- 
men showing unusual capacity cease to be handicraftsmen. 
But the unwillingness on the part of the workers to pay high 
salaries results in the loss of able managers. Having demon- 
strated their ability, the leaders go to competing establish- 
ments where their function is not in such poor repute, and 
where they are given higher salaries, or they go into business 
independently, being able easily to get the needed backing 
from passive capitalists. 

Cooperative schemes thus suffer from the workers' inability 
to appreciate the functions of enterprise and management. 
Most men make a very imperfect analysis of the productive 
process. They see that a large part of the product does not 
go to the workmen; they see the gross amount going to the 
enterpriser ; and they ignore the fact that this contains the 
cost of materials, interest on capital, and incidental expenses. 
Further, they fail to see that the investment function is an 
essential one. The theory of exploitation, as explaining profits, 
is very commonly held in a more or less vague way by work- 
men. With a body of intelligent and thoroughly honest work- 
men, keenly alive to the truth, the dangers, and the risks of 
the enterprise, cooperation would be possible in many indus- 
tries where now it is not. Producers' cooperative schemes 
usually stumble into unsuspected pitfalls. When a heedless 
and over-confident army ventures into an enemy's country 
without a knowledge of its geography, without a map, and 
without leaders that have been tested on the field of battle, 
the result can easily be foreseen. 

The cooperative principle has been embodied much more 
successfully and on a larger scale in America in the form of 
producers' selling organizations or of consumers' cooperative 
stores. As, however, both of these forms of organization have 
been developed in America more largely by farmers than by 
wage-workers, the discussion of them may better be undertaken 
in connection with problems of rural organization rather than 
with those of labor. 



336 WAGES AND LABOR [Pt. IV 

Refebences. 

Adams, T. 8., and Sumner, H. L., Labor problems. 8th ed., K Y. 

Macmillan. 1914. Chs. IV, IX, X. 
Burritt, A. W. and associates, Profit sharing, Its principles and 

practice. Pp. 328. New York. Harpers. 1918. 
Commons, J. R., (Ed.), Trade umionism and labor problems. 1905. 

Second series. Boston. Girm. 1921. (Selected readings.) 
Commons, J. R., and Andrews, J. B., Principles of labor legislation. 

Rev. ed. Harper, 1920. Ch. II, sees. 1-3. 
Fay, C. R., Cooperation at home and abroad. N. Y. Macmillan. 

1898. 
Oilman, N. P., Profit-sharing between employer and employee. Bost. 

Houghton. 1889. 
National Civic Federation. Profit Sharing by American Employers. 

New ed. 1921. (Analysis of 200 plans.) 
Schloss, D. F., Methods of industrial remuneration. 3d ed. N. Y. 

Putnam. 1898. 



CHAPTER 21 



ORGANIZED LABOR 



§ 1. Changing relations between employers and wage workers. § 2. 
Need of common action among wage workers. § 3. Functions of labor 
organizations. § 4. Types of labor organizations. § 5. Statistics of 
labor organizations. § 6. Collective bargaining. § 7. Limitation of 
competition among workers. § 8. Strikes in labor disputes. § 9. Fre- 
quency and causes of strikes. § 10. Picketing and the boycott. § 11. 
Competitive aspect of organization and particular wages. § 12. Mo- 
nopolistic aspect of organization and particular wages. § 13. Open vs. 
closed shop. § 14. Political and economic considerations. § 15. The 
public's view of unions. § 16. Effects of organization upon general 
wages. § 17. Future r6le of organization. 

§ 1. Changing relations between employers and wage 
workers. The "organization of labor," or the "labor move- 
ment," so striking a feature of the world to-day, is of com- 
paratively recent origin. It did not begin and advance pari 
passu with the beginning and early growth of the wage sj's- 
tem as above briefly described.^ In anything like its modem 
form the labor movement dates from the early years of the 
eighteenth century. Much of the largest part of its history 
in all countries, excepting England, is after 1860. Why was 
organization among the workers so long delayed after wage- 
payment became common, and why when it once appeared 
did it spread so rapidly in some directions, and why is it 
still limited in the main to certain fields of industry? These 
three questions are but one question in three forms, and to 
answer one fully would be to answer all. 

The modern trade-union appeared in England shortly be- 
fore the industrial revolution,^ and has extended as fast and 

1 See ch. 20, § 1-3. 

2 See Vol. I, p. 459. 

337. 



338 WAGES AND LABOE [Pt. IV 

as far as the same stage of industrial development has been 
attained in other countries. The effort of wage workers to 
organize themselves appears everywhere to result from the 
separation of the economic and personal interests of employers 
and workmen. As the control of industry became more con- 
centrated in larger units with the advent of power machinery, 
the feeling of economic unity among the different ranks of 
industry was further weakened. The average workman had 
less opportunity of becoming a master, an employer. In the 
days of the old hand industry, master, journeyman, and ap 
prentice worked side by side at the same bench. Almost 
every apprentice might hope to become some time a master, 
and many a one did so. To-day most wage workers in large 
establishments have no hope of rising out of their positions. 
The mere largeness of an establishment forbids also the 
personal acquaintance of employer and workman. As a 
result of these changes, the workmen become more "class-con- 
scious" of their position as wage workers, and the employers 
in many establishments take the attitude of buyers of labor 
as a mere ware. When the employer then feels the pressure 
of competition he is more likely to force the lowest wage that 
is possible and to compel the workers to accept less favorable 
conditions than if he were in more personal relations with 
them. Where the immediate direction of an establishment is 
intrusted to paid managers who are responsible to stockhold- 
ers, the managers' success is judged almost exclusively by the 
dividends they succeed in earning. Hence they are under 
stronger and more persistent temptation than are active own- 
ers to drive hard bargains with their employees. Many exam- 
ples might be found where managers and resident directors 
have wished to pursue a more liberal policy than absentee 
shareholders would permit. 

§ 2. Need of common action among wage workers. 
These same industrial changes caused employers, even earlier 
than it did employees, to have something of a "class-con- 
scious" feeling, which tempered the spirit of their mutual 



Ch. 21] ORGANIZED LABOR 339 

competition, especially in bidding for the services of workers. 
The smaller the number of employers the easier it is by an 
understanding to suppress competition on their side. If there 
is only one factory of a kind in a town the employer is able 
at times to drive a harder bargain with his employees. Espe- 
cially in times of industrial depression is a change of employ- 
ment difficult for the laborer, involving for him much trouble 
and loss of time and money in moving. But it is possible to 
exaggerate the degree to which competition among employers 
of labor is weakened to-day. In the long run and at many 
points competition must be felt in all such cases. The notori- 
ously unfair employer will find his workmen drifting away, 
his working force reduced in number and quality at times of 
greatest need, and his evil reputation going abroad among 
workmen. A better realization of this fact has led many em- 
ployers to pursue a farther-sighted policy that fosters a better 
understanding and a kindlier feeling on both sides of the 
labor-contract. 

Another effect of the growing size of business units is to 
give the workers less personal acquaintance with each other. 
When they are unorganized they have less unity, common opin- 
ion, and power than the workers in the old-fashioned shop with 
its close personal acquaintance and ready interchange of views. 
In the wilderness of a great modern factory a worker may be 
unknown in name and interests to the man touching elbows 
with him. Moreover, in America, differences in nationality 
and in speech among immigrant workers often effectively 
prevent a common feeling of their interests and assertion of 
them. There is an analogy between these conditions and the 
political conditions that early led simple democracies to give 
way to representative governments. As long as a community 
is small and men know each other personally, popular govern- 
ment may exist without complex machinery, but when num- 
bers become larger, public opinion can be concentrated and 
made effective only by delegating the functions to elected 
representatives. 



340 WAGES AND LABOR [Pt. IV 

§ 3. Functions of labor organizations. Out of these con- 
ditions have grown the various kinds of labor organizations. 
(1) their first object is to maintain and increase wages. (2) 
Closely connected with this is the remedying of various 
abuses in respect to methods of payment, measurement 
of the output, and conditions of work. (3) Almost co- 
ordinate with the aim of higher wages of recent years has 
been that of the shorter work-day. Labor leaders have 
frequently asserted, when the two demands have been made 
together, that a reduction of hours is the more desirable. 
(4) Better conditions of safety and sanitation in their 
work were not the first thought of laborers when they organ- 
ized. As a result of habit and ignorance (widely prevalent 
at that time) they were remarkably unconcerned about this 
matter. Reforms in this direction at the outset had to come 
largely from sympathetic observers, the "philanthropists," 
often described as sentimentalists. But the modern, more en- 
lightened labor movement has better ideals and policies in re- 
spect to the safety, sanitation, and decency of working- 
places. 

Labor organizations have also secondary objects of very 
great importance. (5) They are nearly always in some meas- 
ure mutual-benefit associations, and provide in varying degrees 
insurance against accident, sickness, death, or lack of employ- 
ment. (6) All unions in a measure serve their members as 
employment bureaus, and some make this an important fea- 
ture. Through trade papers, correspondence, traveling mem- 
bers, and in meetings, information is exchanged regarding 
conditions of employment in various parts of the country. 
(7) Labor organizations, by means of their discussions and 
through their special periodicals, are a strong educational 
force in matters political and economic. (8) The local labor 
organizations often come to be the center of the social activi- 
ties and interests of many of their members, and even of all 
the members of their families. The organizations thus serve 



Ch. 21] ORGANIZED LABOR 341 

the functions of social clubs, of literary societies, and of 
civic centers for their members. 

§ 4. Types of labor organizations. Among the many or- 
ganizations of wage-earners three main types may be distin- 
guished: the labor-union, the trade-union, and the industrial 
union, though often they are all spoken of as trade-unions 
or as labor-unions without distinction. In the more special 
sense, however, a labor-union is one that admits several classes 
of wage-earners, sometimes even business and professional men, 
into the same local chapter. The Knights of Labor is the 
most notable example that America has seen of this type. The 
national organization was composed of local chapters, to mem- 
bership in which every one was elegible excepting bankers, 
lawyers, gamblers, and saloon-keepers. Organized as a single 
local chapter in 1869, it grew very rapidly until it attained 
its maximum membership of 600,000 in 1886. From this 
point it rapidly declined in membership, and since 1900, 
although its organization is still maintained, has been of very 
little influence, 

A trade-union is an organization of wage-earners in the 
same handicraft or occupation. Unions exist among workers 
in all the old distinctive handicrafts, such as the printers, 
stone-cutters, cigar-makers, carpenters, and in many others 
such as musicians and retail clerks. The local chapters in 
many cases have been long united in national unions (often 
international, embracing the United States and Canada). 

An industrial union is one that seeks to unite all workers 
employed in the same class of establishments, regardless of 
their craft or the kind of work they do. The most notable 
examples are the United Mine "Workers, the Brewery Work- 
ers, and the Industrial Workers of the AVorld. 

In 1881 a number of national trade-unions united, for cer- 
tain purposes, to form the American Federation of Labor, with 
a membership of about a quarter million workers, which has 
steadily increased since that date. The American Federation 
of Labor now includes also some important unions of the in- 



342 WAGES AND LABOR [Pt. IV 

dustrial type.^ Several strong national trade-nnions (the 
most important being fhe brotherhoods of railroad employees) 
are not affiliated with the American Federation of Labor. 

§ 5. Statistics of labor organizations- The ratio of or- 
ganized workers to the population is estimated * to be highest 
in the United Kingdom, being 7 per cent; it is next 
highest in the German Empire, being nearly 6 per cent; 
whereas in the United States it is but 2.3 per cent. This 
difference is largely due to the much greater relative impor- 
tance of agriculture in the United States. 

The total membership of trade-unions in the United States 
and Canada was estimated (in 1910) to have been about 
2,200,000, of which only about 100,000 were in Canada. This 
was 5.5 per cent of all persons (38,130,000) gainfully em- 
ployed, or 6.8 per cent of male employees and 9 per cent of 
female employees. Organization was very weak (less than 1 
per cent) among th^ workers in a group of industries occu- 
pying nearly one half of all workers, including agriculture, 
the hand trades, oil and natural gas, Salt, and rubber facto- 
ries. Organization was not of large extent (1 to 10 per cent) 
in other groups of industries occupying more than one fourth 
of all workers, including those engaged in producing quarried 
stone, food-stuffs, iron, and steel, metal, paper and pulp, sta- 
tionary engineers, in public, professional, and domestic serv- 
ice, and in clerical work. Organization was of much greater 
strength, including 10 per cent or more of the workers, in 
the remaining industries and occupations. 

If deduction be made of the employing and sa^-aried classes, 
about 7.7 per cent of all persons occupied were organized. 
If, further, deduction be made of agricultural, clerical, pub- 
licly employed, commercial, and domestic workers, about 16 

3 In the Federation in 1921 were 111 national and international 
unions, representing 34,000 local unions, 46 state branches, 801 city 
centrals, and 823 local trade and federated labor-unions. 

4 These and the following figures were compiled before the World 
War; no revised estimates are as yet available. 



On. 21] ORGANIZED LABOR 343 

per cent of the remaining 13,760,000 persons were organized 
(of women 3.7 per cent). Among the occupations most 
highly organized are those of railway conductors (87 per 
cent) and engineers (74 per cent). In the building trades 
about 16 per cent were organized, of granite-cutters 69 per 
cent, masons 39 per cent, plasterers 32 per cent, carpenters 
21 per cent, and painters 17 per cent. Similar striking 
differences appear among the occupations in the printing in- 
dustry; of stereotypes 90 per cent were organized and of 
compositors onlj' 35 per cent. These figures point to inherent 
differences in the conditions favoring organization. Even in 
the same craft a high degree of organization may be found 
in the cities and little or none in the smaller towns (e. g., 
in the case of the printing and building trades in general).® 

§ 6. Collective bargaining. The fundamental policy of 
trade-unions is the substitution, for the individual wage bar- 
gain, of collective bargaining between the delegated repre- 
sentatives of the workingmen and the employer, or group of 
employers, or their representatives. The wage-earners bar- 
gaining collectively may be those of a single establishment, 
or of a group of establishments in the same localit}^ or of a 
wider territory, even national in extent. Accordingly, they 
are represented in the negotiations by trade-union officials 
with narrower or wider jurisdiction. Employers in some 
cases had tacit understandings with one another before labor- 
ers were organized. But in many cases the individual em- 
ployer was at a marked disadvantage after the organization 
of his employees. The result has been the rapid spread of em- 
ployers' organizations, so that, in industries where laborers 
are highly organized, two-sided collective bargaining has be- 
come more and more usual. 

A large part of the effort of trade-unions is directed toward 
insuring the use of collective bargaining. This is the pur- 
pose of many of their demands, even of some that hardly ap- 

5 See Quarterly Journal of Economics, May, 1916, article by L. Wol- 



344 WAGES AND LABOR [Pt. IV 

pear to have any such consideration. Collective bargaining 
virtually necessitates the use of the "standard rate," since 
only with reference to some standard rate, a market price for 
labor, is it possible for a wage contract to be made by labor 
officials for a group of men. The standard rate may be a 
piece price or a time price, and in many cases the unions 
strive to secure the latter as more convenient for their pur- 
poses. The standard time rate usually is but a minimum, and 
many of the more skillful workers receive wages above the 
minimum. But the standard minimum tends to become also 
the maximum in many cases, the more so when the union has 
succeeded in enforcing a pretty high standard rate. 

§ 7. Limitation of competition among workers. In order 
that the representatives of organized laborers may act ef- 
fectively in collective bargaining, the first condition necessary 
is that a large proportion, if not all, of the workers of the trade 
in the establishments concerned shall be organized. A com- 
mon sense of wrong is one of the strongest motives to bring 
workers together, and has prompted the origin of many a 
local chapter. Then constant and strenuous efforts are made 
to bring workers into the organized ranks. Experienced or- 
ganizers knowing all the arts of persuasion devote their whole 
time to this task, being paid regular salaries. When friendly 
argument fails, threats may be used, and sometimes personal 
violence. The public opinion and class feeling fostered 
among members of an organization in times of difficulty are 
analogous to the sense of patriotism in the nation at large, 
and at times may displace it in the hearts of organized labor- 
ers, as is seen in opposition to the militia and to the main- 
tenance of order in times of strikes. The most effective of 
all peaceful methods is petty persecution, rising at times to 
social ostracism. The individual who declines to enter the 
union is denounced as a traitor to his fellow workers, and is 
made to feel their scorn. The use of the union card to be 
carried by every member to show whether he is in good stand- 
ing is an effective way of enforcing these measures. Finally, 



Ch. 21] ORGANIZED LABOR 345 

when all these measures fail, pressure may be brout>:ht iipou 
the employer to get him to force unwilling workers into the 
union.® ' 

Further to give control over those working in a trade and 
to reduce competition among workers, unions often limit the 
number of apprentices and determine who shall have the 
privilege of learning the trade. By a variety of regulations 
they limit the output, and in many cases (though less fre- 
quently now) have opposed the use of labor-saving machinery. 
Further to enforce these policies, they seek to have each 
special kind of work controlled by a special union. This gives 
rise to disputes between rival unions, and causes annoyance 
and loss to the workers themselves, to the employers, and to 
the general public. 

§8. Strikes in labor disputes. A strike is a concerted 
stopping of work by a group of employees to enforce a de- 
mand upon the employer. A lockout is an employer 's closing 
of his shop because of a disagreement with his employees. 
The strike is, in its direct and indirect, immediate and ulti- 
mate, effects the most important weapon of the organized 
wage-earners in their relations with their employers. To 
newly organized laborers the union appeals mainly as an in- 
strument for striking, for threatening the employer, or for 
making him suffer to compel him to accede to their demands. 
The effectiveness of a strike lies in the loss it threatens or 
occasions in the stopping of machinery, the ruin of materials, 
the loss of custom, and the failure to complete contracts that 
have been undertaken. 

The employers will often, to break a strike, pay to others 
for a time more than the current rate of wages. The suc- 
cess of the strikers being dependent on their ability to keep 
the employer from filling their places, their energies are bent 
upon that end. The losses that strikes cause to workers in 
stoppage of wages, to employers and investors in destruction 
of plant and in suspension of profits, and to the public in the 

c See below, § 13, on the closed shop. 



346 WAGES AND LABOR [Pt. IV 

interruption of business, aggregate an enormous sum. The 
direct losses to employers and strikers in the twenty years 
between 1881 ,and 1900 were estimated to have been nearly 
$500,000,000, a large sum, but amounting to less than 1 per 
cent of the wage-earners' incomes. It is, however, impossible 
to estimate at all exactly losses that in many cases are indi- 
rect and intangible. The strikers are concerned in each case, 
not with the balance of total losses and total gains to society 
as a whole, but with the net gain that they expect to accrue 
in the long run to themselves. Viewed in this way, it is true 
that there are various indirect benefits in strikes that are not 
easily calculable, particularly the advances of wages made by 
employers to avoid strikes which they know will otherwise 
occur. In regard to the wisdom of any contemplated strike, 
opinion is always somewhat divided, as it is in regard to the 
value of strikes in general. 

§ 9. Frequency and causes of strikes. Strikes were rela- 
tively decreasing in number from 1880 to 1900, but from 1901 
to 1905 the annual average was more than twice as large as 
in the preceding decade. On the whole, strikes have been 
more numerous in periods of business prosperity, when there 
was a better chance to get concessions from the employers. 
But they occur also in the periods following crises, when the 
workers seek to minimize cuts in wages and to prevent the 
depression of working conditions. More broadly viewed, 
strikes appear to accompany readjustments to dynamic condi- 
tions. Since wages, as a rule, rise more slowly than general 
prices, ''• it was to be expected that the period since 1900, in 
which the general price level was rising at the rate of about 
3 per cent a year, should have been marked by increasing 
resort to strikes. 

The immediate causes of strikes have been changing in rela- 
tive importance. In 1881, at the time of the very rapid or- 
ganization of unions, more than 71 per cent of all strikes were 
directly connected with wage demands (61 per cent for in- 

7 See Vol. I, pp. 223-224, and above, ch. 6, § 10. 



Cir. 21] ORGANIZED LABOR 347 

crease and 10 per cent against reduction). But in 1905 the 
total for these causes was only 37 per cent, whereas the pro- 
portion of strikes for reduction of hours ncarty doubled (from 
3 to 3 per cent) and the proportion of these concerning recog- 
nition of unions and union rules increased fivefold (from 6 
to 31 per cent). Ultimately nearly eveiy demand of the 
laborers is related to the question of wages; but these figures 
show that when organization is new this relationship is more 
immediate, whereas later more effort is directed toward secur- 
ing the stronger strategic position that comes with recognition 
of the union. 

§ 10. Picketing and the boycott. Picketing by strikers 
or their friends is intercepting and accosting all persons ap- 
proaching or leaving the place of work, to inform them of 
conditions and to dissuade them from working there. When 
peaceable means fail, often there is recourse to violence both 
against the employer and his property and against non-strik- 
ing workers. Indeed, many persons declare that peaceable 
picketing is impossible, and it surely is difficult to attain in 
view of the temptations of human nature under the circum- 
stances. 

Almost always connected with a strike is the practice of the 
boycott, which is a combination of wage-earners to cut off an 
employer (or group of employers) from business dealings. 
The boycott is found in varying forms and degrees, broadly 
distinguished as simple and compound boycott. In simple 
boycott only persons directly interested in the trade dispute 
refuse to deal with the boycotted person. The question arises 
as to who are to be deemed directly interested, whether only 
the actual strikers in a particular establishment are included, 
or whether organized workers in sympathy with them are in- 
cluded. The latter case is presented when an "unfair" list is 
published in labor journals. It seems that only the former 
case is a really simple boycott. The use of the simple boy- 
cott, the refusal of a person, or even of a conspiring group 
of persons, to deal with a person with whom they have an 



348 WAGES AND LABOR [Pt. IV 

industrial dispute, appears to be a part of the elementary 
rights of personal liberty. Beyond that point the boycott is 
compound in varying degrees. It is the compound form 
that is usually referred to in discussion and in court deci- 
sions on the subject. It is the compound boycott that has been 
described as "a combination to harm one person by coercing 
others to harm him." The compound boycott, as experi- 
ence shows, has moral limits as well as legal limits. It is 
doubtful whether the boycott can be extended at all beyond 
the first degree of personal relations without becoming anti- 
social, whether it is the weapon of organized workers or of 
organized wealth. The endless-chain boycott, a measure of 
excommunication without limit, pronounced against an of- 
fending employer, non-union workers, and every one in any 
way befriending them, is an effort to drag every one else into 
a dispute that is primarily a private matter. 

The "unfair list" is usually given as a form distinct from 
either the simple or compound forms of boycott. The "fair 
list," published either by labor journals or by a consumer's 
league is not declared to be a boycott. 

§ 11. Competitive aspect of organization and particular 
wages. The crucial economic problem in connection with 
trade-unions is not as to their methods (that being rather a 
political problem) but as to their effect upon wages. There 
must be distinguished two questions : first, as to the influence 
of organization upon particular wages, and primarily upon 
the wages of organized labor ; and, next, as to their influence 
upon the general level of wages. 

As to the first, it may be seen that the wages of workers 
who are organized are generally (though not always) higher 
than those of unorganized workers in the same trades and 
neighborhoods. An English trade-unionist, Trant, says; 
"Where there are no unions wages should be lower. This 
is exactly the case." And he quotes: "Wherever we find 
union principles ignored, a low rate of wages prevails, and 



Ch. 21] ORGANIZED LABOR 349 

ihe reverse where organization is perfect." (1) But he 
later explains in part this difference: ''The union men 
are the best workmen and often emploj^ers pay a man more 
than union wages. This is not surprising, as no man can be 
a union carpenter unless he be in good health, have worked 
a certain number of years at his trade, be a good workman, 
of steady habits and good moral character." If this be 
true, as doubtless it is to some degree in many trades and 
places, it is in accordance with competitive principles that, 
as the elite of the trade, the organized laborers should get 
higher wages than those outside the unions. (2) Moreover, 
the unions exist mainly in the more populous places, where 
costs of living as well as wages range higher than in the 
small towns and in the rural districts. A comparison merely 
of wages in money in such cases is misleading as to the con- 
ditions of real income. (3) Further, a higher standard of 
output prevails in the cities where organization i» greatest, 
and older men and the less efficient, who are unable to ''keep 
up the pace," drift away into unorganized shops or to villages 
where no standard union rate is in force. (4) As far as 
unions help to develop the intelligence and promote the 
sobriety and efficiency of their members, they are a positive 
economic force making for higher wages. (5) Organization 
may help to raise particular wages, inasmuch as it helps 
to restore to the laborers a truer equality in the making 
of the wage contract, by creating two-sided competi- 
tion. 

The book before quoted expresses, somewhat vaguely, an 
opinion in accord with these facts and principles when it 
says: "It is an error to think that the trade-union seeks 
to determine the rate of wages. It cannot do that. It can 
do no more than affect them." "With organization as well as 
without it, the wages of individuals and of classes of laborers 
are determined by the general principles of competitive price 
as applied to their services, where neither the employer has 
a monopoly of employment nor the organized laborers have 
a monopoly of the labor supply. 



350 WAGES AND LABOR [Pt. IV 

§ 12. Monopolistic aspect of organization and particular 
wages. The action of organized labor is not, however, lim- 
ited to the competitive field. Wages in particular industries 
may, by the action of trade-miions, be raised and maintained 
above a true competitive rate. This, of course, can be done 
only in accordance with the principles of the service value to 
the consumer and of service price in the employment market. 
.The supply of labor is in a variety of ways artificially lim- 
ited by the efforts of the unions. (1) It may be done tem- 
porarily by striking when a failure to fill orders will cause 
the employer exceptional loss. (2) Violence in strikes and 
boycotts is often the desperate attempt to create and assert 
a measure of monopoly power where of itself it does not exist, 
i. e., where other workers stand ready to take the jobs at 
the prevailing rates of wages. (3) It is created if appren- 
tices are limited to fewer than in the long run would be 
attracted* into the trade by the prevailing wages. (4) It 
is created if the unions artificially limit output to less than 
is consistent with the health of the worker. (5) It is created 
if unions strong enough to keep "scabs" from getting work, 
fix their dues high or put other obstacles in the way of in- 
creasing the membership. Probably the most striking cases 
of high wages for organized labor are of this kind. The ele- 
ment of labor monopoly evidently is mingled in all degrees, 
from the slightest to a very great amount, in particular eco- 
nomic' situations. 

§ 13, Open vs. closed shop. The question of labor 
monopoly is involved in the very crucial question of the closed 
vs. the open shop. A closed shop (or union shop) is a shop 
in which no non-unioin men may be employed, even at union 
wages. Unions usually assert that the closed shop is essential 
to the existence of the union, although some strong unions, 
notably the Railroad Brotherhoods, have not urged this point. 
The existence of a closed shop is evidence that the union is 
strong enough to compel the employer to act on this principle 
and thus virtually to force all his employees into the union. 



Ch. 21] ORGANIZED LABOR 351 

The refusal of a demand for the closed shop is often the 
ground for a strike. If union and non-union men work side 
by side there are so many ways in which the employer is able 
to discriminate so as gradually to break down the union. If 
business slackens, the union man may be the first to be dis- 
charged; if any preference is given it is to the non-union 
man. Therefore, most spokesmen of organized labor believe 
and declare that efforts of employers to secure or to maintain 
the open shop are disguised attacks upon the very principle 
of organized labor. Labor leaders ridicule as hypocritical 
the employers that say they are trying, in keeping their shops 
open, to protect the workmen's liberty to join or not to join 
a union, which in the eyes of the law is a voluntary organiza- 
tion. 

While these accusations may too often be true, it would 
seem, on the other hand, that an unmodified closed shop, 
with the conditions of membership in the control of the union, 
creates a distinct monopoly of labor, leaving the employer 
helpless in any wage dispute and enabling the uilion to en- 
force its every demand, regardless of the competitive condi- 
tions of the labor market for that class of services. The 
employers, in , their more moderate claims, profess to aim 
at an ope7i shop only in the sense of the principle laid down 
by the governmental Anthracite Coal Commission of 1902, 
as one where no person is "refused employment, or in any 
way discriminated against, on account of membership in any 
labor organization"; and where there is "no discrimination 
against or interference with any employee who is not a mem- 
ber of any labor organization, by members of such organiza- 
tion." Such an open shop, with its conception of two-sided 
duty, fairness, and toleration, nearly commands public ap- 
proval, acquiescence, and acceptance by both sides. But un- 
fortunately, in practice, whichever side chances to get the 
upper hand in the situation is too often tempted greedily and 
ruthlessly to push its advantage far beyond the ideal point 
of toleration. 



352 WAGES AND LABOE [Pt. IV 

In the war and after-war boom period from 1917 to 1920 
the greater bargaining power of organized labor enabled it 
to push not only for higher wages and shorter hours, but 
for the closed shop, which made great headway. The rail- 
roads, under federal control by the Railway Administration, 
were almost completely unionized, and great numbers of 
manufacturers conceded the closed shop to the unions. In 
1920, with the onset of unemployment, began a most active 
propaganda in favor of the open shop. This produced, prob- 
ably, an exaggerated effect upon the public mind, seeking a 
scapegoat for the high cost of living, and finding easy ex- 
planations in "profiteers" on the one hand, and on the other 
in the unreasonable demands of labor, excessive wages, and re- 
duced output. The effect was to neutralize in large part 
within the year the gains made by the closed shop, and to 
produce alarm in circles of organized labor. 

§ 14. Political and economic considerations. The ques- 
tion of the closed or open shop has some very broad aspects. 
Is the closed shop, and are the other policies of trade-unions, 
morally right ; and ought they to be legally sanctioned ? Such 
questions are not for the economist alone to answer. They in- 
volve moral and political considerations — not merely exist- 
ing formal law, but the fundamental issue of personal 
liberty and of interference with the liberty of some citizens 
by another group acting without political authority. For 
example, if a workman is unable to earn the standard rate ^ 
and is not permitted to take less, he is forced to move to 
a place where there is no union, or is forced out of the trade 
entirely. In the latter case he probably is compelled to take 
a lower wage than he could get in his regular occupation. 
Likewise, this change artificially increases the pressure of 
competition and reduces the wages of others in the occupation 
to which he turns. So, in the case of persons prevented from 
becoming apprentices in a trade, or kept from taking work 
by threats, or by the dread of boycott, or by the fear of viol- 

8 See §11. 



Ch. 21] ORGANIZED LABOR 363 

ence, in any degree however slight, there is present an ele- 
ment of personal coercion by the organized laborers. This 
is the price others are made to pay for a favorable effect on 
the wages of the organized laborers. Now, the more strict!}^ 
economic question concerns the part as to the effects upon 
wages, and hardly extends to a judgment on the moral recti- 
tude (and the desirability in law) of such acts and policies. 
One who fully shares the feelings of the organized workers 
will believe that the winning of a strike or the general im- 
provement of the strikers' condition is so important that it 
outweighs the evils to other individuals and to society as 
a whole. Indeed, to one in that state of mind the evils 
appear very small or non-existent. The economist can only 
issue the warning that the commonest illusion he encounters 
is the belief of each class — commercial, banking, manufactur- 
ing, wage-earning — that what is for its particular interest is, 
in a peculiar manner, for the general interest, so much so 
as to justify favoring legislation or special exemption from 
the general law, or even sheer lawlessness. 

§ 15. The public's view of unions. AVe may, however, 
observe the view of the onlooker striving to be impartial. 
The attitude of the public in labor disputes, and particularly 
in regard to the closed shop, is a vacillating one. The gen- 
eral public sympathizes in large measure with the unions in 
their efforts up to a more or less certain pomt ; but the 
public does not like to see organized labor with the power to 
dictate terms absolutely to the employers, any more than it 
likes to see employers crush the union. The unions are ef- 
fective in varying degrees in strengthening the bargaining 
power of the workers, and accordingly the results vary not 
merely in degree but in kind. The public wishes to see ''fair 
play," and up to a certain point the union is a device to get 
fair play. In truth, what is in the public's thought, some- 
what vaguely, is approval of unions as far as they go to es- 
tablish a real equality in competitive bargaining with the 
employers, but disapproval where the power of the union gets 



354 WAGES AND LABOR . [Pt. IV 

greater and becomes monopolistic. It is at this point that 
organized labor loses the sj^mpathy of most of the "general 
public" outside of unions. When the union tries to force a 
higher wage than the market will warrant, when it strives not 
to establish but to defeat competition, the public condemns. 
It sees, though not quite clearly, that such action makes an un- 
stable equilibrium of wages, which tempts to constant friction 
and discord with employers and with unorganized laborers. 
It sees also that if the unions force a wage higher than a fair 
and open market affords, this is rarely done at the expense 
of the employer; that in the long run it is at the expense of 
the purchasing public itself, including the unprivileged work- 
men. 

In accordance with these facts and opinions there has devel- 
oped, at least in one respect, a pretty definite conviction on 
the part of the public regarding the closed shop, namely : the 
closed shop should go only with the open union. A union 
under the closed-shop policy is exercising a quasi-public func- 
tion, that of controlling the industrial action of private citi- 
zens against their will. The union, therefore, in this view, 
must, with anything like the closed shop, cease to be a purely 
private, voluntary organization, and become in some respects 
subject to public regulations as to its internal rules and ad- 
ministration. This view, however, is very unacceptable to the 
leaders of organized labor in America, and there the question 
now stands. 

§ 16. Effects of organization upon general wages. A 
question different from that discussed above is as to the effect 
that the organization of labor has upon the general level of 
wages, including those of unorganized workers. The thought 
has sometimes been expressed by sympathetic social students 
outside of trade-union circles that, but for the organization 
of labor, wages in general in America would be no higher 
than they were in 1850. This seems to be assumed in much 
v of the argument of labor leaders, for they speak as if all wages, 
but for trade-unions, would be at the starvation level, and 



Ch. 21] ORGANIZED LABOR 355 

they credit everything above that level to the work of the 
unions. In Trant's book alread}' referred to, which was re- 
printed and circulated by the American Federation of Labor 
as representing its theory and claims, all the advances that 
have been made in wages are attributed to the trade-unions. 
This claim is peculiarly effective in America, where wages are 
and always have been relatively high. But proof of the 
claim is lacking. As we have seen, fewer than one in sixteen 
of all gainfully employed and fewer than one in twelve 
of those working for contractual wages have been organized. 
On no principle of value could the mere organization of one 
twelfth of the wage-earners, without permanently withdraw- 
them from the labor market, explain the relatively high 
wages of the other eleven twelfths. In many lines where 
labor is not organized, as in teaching, clerical, professional, 
domestic, and agricultural services, wages have risen as much 
or even more than in most of the organized trades. The un- 
derlying economic forces determining the general level of 
labor incomes in a country are much more fundamental in 
nature than labor-unions or protective tariffs.® The trade- 
union authority already cited seems in another passage to 
admit a view not essentially unlike that just expressed when 
he says: ''Capital is increasing faster than population. 
... It seems therefore merely in obedience to natural laws 
that wages should rise." 

The only reasons ever suggested for thinking that the or- 
ganization of one twelfth (or any larger proportion of the 
wage-earners) could in any general way raise the labor in- 
comes of those remaining unorganized are : first, that organ- 
ized labor sometimes leads the way in securing favorable 
legislation ; and, secondly, that if organized workers get higher 
wages this sets a standard which it is easier for the unorgan- 
ized then to attain. Both of these suggestions may have some 
little validity in special cases, effecting slightly a small pro- 
portion of the unorganized workers, but neither touches 

9 See Vol. I, pp. 227, 439, 466, 504^507; and above, ch. 16, § 8. 



350 WAGES AND LABOR [Pt. IV 

fundamental causes of general high wages. Whereas it is 
clear that when the unorganized laborers constitute the main 
body of consumers for the products of organized labor (and 
this unquestionably is in large measure the case) any increase 
in wages that can be secured through organization by a por- 
tion of the workers must, in part, be subtracted from the 
"real" incomes of the unorganized workers. The employer 
is middleman, not to a great degree the ultimate consumer, of 
labor.^*' Some part, it is true, of the higher wage might be 
taken from profits or from wealth incomes, but this would 
still leave the unorganized workers the losers. 

§ 17. Future role of organization. In the light of the 
principles of wages and of experience, it appears that organ- 
ization most easily gains results when wages are below the 
competitive rate ; and it gets the most stable results when 
wages are kept at or little above the competitive rate. Only 
exceptionally is the control of a labor organization in a trade 
so strong that it is able to maintain monopoly wages 
for long periods. An earnest effort on the part of the 
workers is necessary for them to get the share that true 
competition would accord them, but the attempt to force 
wages beyond that point must be the occasion of increasing 
friction. With so modest an ideal, however, as the true com- 
petitive wage, organized laborers and their leaders cannot be 
expected always to be content. 

Aside from its effects upon the wage bargain, unionism 
finds its greatest justification is in its unspectacular fraternal, 
mutual-benefit, and educational functions. The chief forces 
favorable in the long run to wages that can be affected by 
organization are domestic peace, order, and security to 
wealth ; honesty and good faith between worker and employer, 
in law-maker and in judge; efficiency and intelligence of the 
workers ; and far-sighted social legislation. Some of these con- 
tribute to greater productiveness, others to a fairer distribu- 
tion. In all these ways organized laborers have made valu- 

10 See Vol. I, pp. 217, 222-223, 352, 356. 



Ch. 21] ORGANIZED LABOR 357 

able contributions, unfortunately neutralized in many cases 
by a narrow class outlook. Organized labor is here to stay 
for a long time to come, and as the elite of the wage-earning 
class it should, and probably will, be an increasing force for 
political betterment and for social welfare in the republic. 

References. 

Adams, T. S. and Sumner, H. L., Labor problems, chs. VI, VII. N. 
Y. Macmillan. 1914. 

Carlton, F. T., The history and problems of organized labor. Revised. 
N. Y. Heath. 192(K 

Commons, J. R., and associates, History of labor in the United 
States. 2 vols. N. Y. Macmillan. 1918. 

Commons and Andrews, Ch. Ill, sec. 1. Principles of labor legisla- 
tion. Rev. ed. N. Y. Harpers. 

Gompers, »S'., Labor and the common welfare. Pp. 306. New York. 
Dutton. 1919. (Extracts from Mr. Gompers' articles and ad- 
dresses made during the past thirty-five years.) 

Groat, G. G., An introduction to the study of organized labor in 
America. N. Y. Macmillan. 1916. 

Hoxie, R. F., Scientific management and labor. N. Y. Appleton. 
1915. 

Hoxie, R. F., The truth about the I. W. W. J. P. E., 21: 785- 
797. 1913. 

Hoxie, R. F., Trade unionism in tlie United States. Pp. 426. N. Y. 
Appleton. 1917. (General character and types; the interpretation 
of union types.) 

McCabe, D. A., The standard rate in American trade unions. Bait. 
Johns Hopkins. 1912. 

Mitchell, John, Organized labor. 1902. 

Wehh. Sidney and Beatrice, Industrial democracy. Pp. 899. N. Y. 
Longmans. 1920. 

Same, History of trade unionism. Pp. 784. Revised edition. N. Y. 
Longmans. 1920. 

Wolman, L., The boycott in American trade unions. Johns Hop- 
kins. 1916. 



CHAPTER 22 



PUBLIC REGULATION OF HOURS AND WAGES 

§ 1. Spread of the shorter working-day. § 2. The shorter day and 
the lump-of-labor notion. § 3. Fewer hours and greater efficiency. § 4. 
Child-labor. § 5. Child-labor legislation. § 6. Limitation of the work- 
ing-day for women. § 7. Limitation of the working-day for men. § 8. 
Broader aspects of this legislation. § 9. Plan of the minimum wage. 
§ 10. Wage theory in the minimum wage. § IL Limitations of the 
minimum wage, § 12. Mediation and voluntary arbitration. § 13. 
Compulsory arbitration. § 14. Organized labor's attitude toward labor 
legislation. § 15. Organized labor's opposition to compulsory arbitra- 
tion. § 16. The public and labor legislation. § 17. The public and 
compulsory arbitration. 

§ 1. Spread of the shorter working'-day. Since about 
1880 a shorter working-day has been one of the prime objects 
of organized labor in America. Notable progress was early 
made in some trades, reducing hours from eleven to ten, 
or from ten to nine, and in a few cases from nine to 
eight. In the building trades in the cities, especially, the 
eight-hour day has come to be well-nigh the rule. In 1912 
it was estimated ^ that 1,847,000 wage-earners were working 
in the' United States on the eight-hour basis ; of these 475,000 
were public employees, A large proportion of the remainder 
were women and children whose hours were limited by ilaw, 
or were men working in the same establishments with them. 
Since that date the eight-hour day has been more widely 
adopted both through private action in many establishments 
and by legislation. Beginning in 1915, occurred an especi- 
ally rapid spread of the eight-hour day, continuing through- 
out the period of rising prices until 1920. 

1 By the Secretary of the American Federation of Labor. 

358 



Ch. 22] ri'BLIC REGULATIOX OF HOURS AND WAGES 3o0 

§ 2. The shorter day and the lump-of -labor notion. The 

shorter working-day is advocated by most workers in the be- 
lief that it will resnlt, not in less pay per day, l)nt in even 
greater pay than the longer day, even if the ontpiit should be 
decreased. This view is connected with the Inmp-of-labor 
notion.^ It assumes that men will work no faster in a shorter 
day, and that there is so much work to be done regardless 
of the rate of wages ; and concludes that the shorter day will 
reduce the amount of labor for sale and cause wages to rise. 
To the extent, however, that laborers, as consumers, mutually 
buy each other's labor, evidently this loss due to curtailing 
production must fall upon the laborers as a class. The work- 
ers naturally desire and. strenuously demand the same daily 
pay for a shorter day, which means a higher wage per honr. 
If wages per hour increase less than enough to make up for the 
fewer hours, the purchasing power of the workers must be re- 
duced. If the output per hour is increased proportionately to 
the pay per hour, the existing wages equilibrium would not be 
disturbed. But if the output increases not at all or in less 
than the proportion of the increase in pay, there is an in- 
evitable disturbance of the wage equilibrium. In a competi- 
tive industry this would compel a speedy readjustment of 
wages downward. If a certain group, or large number, of 
workers were to begin turning out only 80 per cent as large 
a product as they did before, while getting the same money 
wage, the costs per unit would be thereby increased. Prices 
must rise or many of the establishments must close, and 
then prices would rise as a result. This must throw some 
of the workmen out of employment and create a new bargain- 
ing situation for wages. 

But, it is said, let the general eight-hour day be applied 
to every industry and to all wage workers at once, — then 
all workers and all employers m the industry would be in a 
like situation. At once, however, there must occur clianges of 
consumers' choices in a great number of ways. If there are 

2 See Vol. I, pp. 458-467. 



360 WAGES AND LABOR [Vt. IV 

one fifth fewer goods, evidently at least one fifth of the con- 
sumers must go without. These would largely be the wage 
workers. The things of which wage labor makes up a large 
part of the costs will rise in price relative to the things of 
which self-employed labor and of which materials and ma- 
chinery make up a relatively larger part. This must com- 
pel a reduction of the demand for the products of wage 
labor relative to other things, and be reflected to labor in a 
lower wage. This reduction would not necessarily be just in 
proportion to the reduced output (that is, say, 20 per cent 
if from ten to eight hours, or 11 per cent if from nine to eight 
hours). It might even be more, but probably would be some- 
what less. In any case, both the money wages and the real 
wages of laborers, either in the particular trade or generally, 
must be reduced by a general reduction of hours that results in 
a decreased output. In such cases, even when the workmen 
by a strike or general movement secured the same wage scale 
for a day of fewer hours (a higher wage per hour), they 
would be unable to hold it excepting where they had monopo- 
listic control of the trade. 

The conclusion to which the foregoing reasoning has led 
is, then, that, excepting in certain situations of labor monop- 
oly which are comparatively rare, the shorter day will not 
raise total wages when it cuts down production, certainly not 
for the reason that it cuts down production. When the 
working-day is already not so long that it exhausts the 
physical and nervous powers of the workers, a general re- 
duction of hours without increased production per hour will 
reduce the real incomes of the workers, as well as those of 
the whole community. However, a reduction of hours is eco- 
nomically justified, even if material production is reduced, if 
the working-day is so long that it is injurious to health, to 
morals, and to family life. In that case the disutility of the 
later hours doubtless exceeded to the workers and to society, 
the utility of the additional material product. 

§ 3. Fewer hours and greater efficiency. A very differ- 



Ch. 22] PUBLIC REGULATION OF HOUR,-^ AND \YAGKS 361 

ent argument for the shorter day is that the rate of work 
may be so increased that the output remains at least as 
large as in the longer day, or even larger. A faster work- 
ing pace is possible in many cases with the shorter day, 
particularly in those operations calling for physical or mental 
dexterity. This view is less attractive to the workers than 
the preceding one, but is more acceptable to the employers and 
to the public. The change to fewer hours undoubtedl}' has 
resulted in many cases in larger production, and could be 
made to result so in manj^ other cases by applying the methods 
of scientific management. But it is a change that cannot 
be repeated indefinitely and under all conditions with like 
favorable results. Whether in any particular case it can 
be depends in part on the length of the working-day at the 
start. Such an increase in output might occur in a change 
from exhausting hours, as from twelve to ten, and again from 
ten to nine, and yet not be possible in a change from 
nine to eight. JMoreover, the speeding up of the work- 
ers beyond a certain point may have had physiological effects 
outweighing the benefit from shorter hours. It is now said 
that with the increase of automatic machinery there are more 
and more workmen who much of the time have merely to 
watch the machine-tool run, and occasionally adjust the ma- 
terial. There has, however, been collected a notable body of 
evidence to show that, in many industries and in different 
establishments using much machinery, a reduction of hours 
to a number as few as eight has been followed by the in- 
crease of the output per worker, or by improvement in the 
quality of work, or by improvement in the management, re- 
sulting in a reduction of the cost of production. This is 
often sufficient, or more than sufficient, to compensate for the 
shorter time. Wages have remained as high as, or higher 
than, before, and employment has been more regular. As far 
as this result is due to the individual worker, it is explained 
by the same evidence referred to below ^ as bearing upon the 
3 See especially, § 8. 



I 



362 WAGES AND LABOR [Vt. IV 

health of the worker. This evidence tends to prove that with! 
longer periods of rest and recreation the worker lives in a 
physical and mental condition fitting him far better for his 
work and for continuing his working life. 

All of the foregoing arguments are weighed in terms of 
private incomes and of the value of the products, whereas 
the main considerations that have of late been influencing 
legislation and judicial decision in favor of shorter hours 
have been those of public welfare. The legal limitation of 
working hours is being treated primarily as a health measure, 
into the judgment of which is more and more entering a 
broader conception of the happiness, morality, and opportuni- 
ties for good citizenship for the worker and his family. 

4. Child-labor. In agricultural conditions, such as have 
prevailed generally in America, there is little need of limiting 
the hours of work for children and the age at which they 
may begin to work. The barefoot boy trudging over clover- 
fields to carry water to the harvesters may be the happier, 
healthier, and better for his work. Child-labor in agricul- 
ture has never become a social "problem" so long as the 
children work with their own parents at their own homes; 
but the labor of children for wages, especially in gangs on 
large farms (as in beet cultivation and cranberry-picking) 
or in canning factories, has exhibited evils as pronounced as 
any in urban manufacturing conditions. 

The evil of forcing children into factories was early recog- 
nized. The most obvious evils of child-labor are neglect of 
the child's schooling; destruction of home life; overwork, 
overstrain, and loss of sleep, with resulting injury to health ; 
unusual danger of industrial accidents; and exposure to de- 
moralizing conditions. The usual assumption that the worker 
is able to contract regarding the conditions of labor on terms 
of equality with the employer is most palpably false in the 
case of children. The child, subject to the commands of his 
parents and guardians, is not a free agent. Often poverty 
leads parents to rob their children of health, of schooling, 



Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 363 

and of the joys of childhood. Lazy fathers are tempted to 
support themselves in idleness on the wages of their young 
children. In some immigrant groups, particularly, conditions 
of child-serfdom have developed in America. The competi- 
tion of child-labor also depresses the wages of adults, and 
thus the evil grows. 

§ 5. Child-labor legislation. The limitation of hours was 
first applied to children working in English factories early 
in the nineteenth century, and thence has extended throughout 
the world, tardily following the spread of the factory sys- 
tem. The first American law of the kind was in Massachu- 
setts, in 1842, limiting to ten hours the labor of children under 
twelve years of age in manufacturing establishments. Fol- 
lowing this, all the earlier state laws fixed the minimum age 
low and the maximum of hours high, and the laws were 
poorly enforced for lack of adequate administrative machinery 
and of public interest. In all these respects many states 
gradually improved their child-labor laws in the latter part 
of the last century, and much more rapidly since 1903. 
Now the maximum working-day for children in about one 
half of the states is eight hours, in one quarter is nine hours, 
and in one quarter is ten hours (and in a few southern states 
eleven hours). Night work by children is very generally for- 
bidden (in about forty states). During the same time the 
minimum age has been pretty generally raised to fourteen 
5'ears for factory work, with higher ages (sixteen, eighteen, 
or even twentj'-one) in some states for certain occupations 
dangerous to health or morals. In addition to these general 
limitations, special provision is made for individual examina- 
tions, to determine whether the child is mentally and physi- 
cally fit to work and has met the requirements of the com- 
pulsory education laws of the state. 

The culmination of years of effort in and out of Congress 
was the enactment, September 1, 1916, of a child-labor law 
that prohibited the interstate shipment of goods produced 
in factories wherein any child had, within thirty days, been 



364 WAGES AND LABOR [Px. IV 

employed under unfavorable conditions as to hours of work 
as specified in the act. This act was soon, however, declared 
^ unconstitutional. Another way of attacking the problem 
through the use of the federal taxing power was then found. 
In the so-called "Revenue Act of 1918" (enacted February 24, 
1919) a child-labor employment tax was imposed on the entire 
net profits of persons or of corporations emplojdng children 
at specified times and under specified ages (sixteen in mines, 
fourteen in mills, canneries, workshops, or factories). The 
constitutionality of this act has been questioned in a district 
court, but, up to this writing, not in any higher federal juris- 
diction. , 

In the labor section of the treaty of Versailles of 1919, 
among the nine points, or general principles, held to be of 
special and urgent importance, the sixth reads : ' ' The aboli- 
tion of child-labor and the imposition of such limitations on 
the labor of young persons as shall permit the continuation 
of their education and assure their proper development." 

Child-labor legislation, viewed as a merely negative policy, 
^ is not of great moment. Its real significance is to be judged 
only in connection with the broader social policy of protect- 
ing and developing all of the children of the nation to be 
healthy, intelligent, moral, and efficient citizens. Children 
growing into blighted and ignorant manhood and womanhood 
are threats to society. 

§ 6. Limitation of the working-day for women. Legisla- 
tion to limit the hours and conditions of employment of women 
usually comes later than the limitation of child-labor. The 
grounds of special laws to protect workingwomen are that 
women are less able than men to protect themselves in the 
labor contract, that they are physically weak and are pe- 
culiarly exposed to certain dangers to health, that as future 
mothers they need protection for their own and the public 
welfare, and that in the period of maternity the dangers 
are especially great. The work of women in factories oper- 
ates in some ways to depress the wages of men, and it is harm- 



Cir. 22] riULK' RECULATIOX OF HOURS AND WAGES .305 

fill in its effects upon the home and family life. At present 
five states limit the hours of women to eight a day, 
twelve to nine a day, fifteen to ten a day, four to eleven or 
less a day. A number of states forbid the work of women 
in designated places of work, such as saloons, mines, or 
where constant standing is required. Only as late as 1911, 
in America, has legislation, now in four states, given maternity 
protection, as is now more fully provided in European coun- 
tries in connection with systems of health insurance. 

In all of the great industrial countries of Europe night 
work by women is restricted (prohibited between 10 p. m., and 
5 A. M., or yet more narrowly limited) ; but legislation along 
this line is found in only eight American states. 

§ 7. Limitation of the working-day for men. The gen- 
eral assumption made in law has been that the adult male 
worker is competent to judge of the working conditions, hours 
of labor, and wages, and is capable of protecting his own in- 
terests sufficiently by his power of refusal to accept employ- 
ment. The legislatures have, much more tardily than in 
their legislation for children and for women, acted contrary 
to this assumption ; but, when this has been done, the courts 
in America have vigorously asserted the general doctrine and 
denied the constitutionality of the laws. However, some ex- 
ceptions were made in legislation, and, after much apparent 
hesitation and vacillation, were allowed by the courts to 
stand, and these have now grown in number until they form 
an impressive total. 

These exceptions have come in various ways. There is, ' 
first, the eight-hour limitation in public employment, required 
in federal employment in 1868, really effective since 1892, 
and now in force likewise in about two thirds of the states. 
In almost the same jurisdictions — national, state, and munici- 
pal — eight hours is the legal day for work done by private con- 
tractors for the government. Work on railroads and street 
railways, particularly in the direct operation of trains, such 
as the work of dispatchers, signalmen, and trainmen, is sub- 



366 WAGES AND LABOK [Pt. IV 

jected to a large variety of regulative measures, hours being 
limited in some cases to eight, in others to nine, ten, twelve, 
or sixteen, and in a number of cases a specified minimum num- 
ber of hours of rest is required after the maximum hours of 
labor. These laws are primarily for the protection of the 
public, but they afford a protection to the employee much 
needed, as many well authenticated cases of excessive and ex- 
hausting hours demonstrate. 

The limitation of hours has very recently been extended to 
many private businesses in which exceptional conditions exist 
affecting the health of the workers or the safety of the pub- 
lic. This development has occurred almost entirely since the 
United States Supreme Court in 1898 (Holden vs. Hardy) 
sustained a Utah statute limiting to eight the hours of labor 
in underground mines. Now eight-hour laws in certain speci- 
fied cases are found applying to mines, smelters, tunnels, and 
a variety of other kinds of work, and in a few cases the limit 
is nine, ten, or eleven hours. 

§ 8. Broader aspects of this legislation. The subject took 
on a new aspect when the legislature of Oregon, in 1913, de- 
clared broadly that "no person shall be hired, nor permitted 
to work for wages, under any conditions or terms, for longer 
hours or days of service than is consistent with his health and 
physical well-being and ability to promote the general welfare 
by his increasing usefulness as a healthy and intelligent citi- 
zen, ' ' and fixed ten hours as the limit of work consistent with 
such a measure of health and welfare, in work in any mill, 
factory, or manufacturing establishment. This law was sus- 
tained by the Supreme Court of that state, and on appeal the 
decision was affirmed by the United States Supreme court.* 
In support of the law there was presented a voluminous brief 
giving a most impressive body of evidence from scientific and 
from practical business sources, to show the many evils, popu- 
larly unsuspected or underestimated, that result from long 

4 Bunting vs. State of Oregon, 243 U. S. 426 (Oct., 1916). 



Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 367 

hours even in industries of no exceptional hazards.^ Psysio- 
logical and psychological tests demonstrate that the fatigue 
following more than a moderate working period not only re- 
duces immediate efficiency, but so poisons the system that 
greater liability to accident, disease, intemperance, immo- 
rality, and premature decay results. 

Two main purposes appear somewhat intermingled in this 
legislation in limitation of hours. The first purpose is to pro- 
tect the public directly where the safety of others is dependent 
on the health and efficiency of the worker. The second pur- 
pose is to protect directly the worker's health and welfare, that 
policy being recognized to be in the long run the best like- 
wise for the public welfare. In legal reasoning it is being rec- 
ognized that the individual wage worker, even the adult male, 
is not in a position to judge the number of hours he ought, 
for his own good, to work, and is unable to fix the length of 
his own working-day. As a matter of economic theory, the 
usance of a child, a woman, or a man is merely that kind 
and amount of service that can be given out by each without 
repressing the normal possibilities of growth, reducing the nor- 
mal health and vigor, or shortening the normal period of 
healthy productive human existence.*^ It is becoming a gen- 
eral social policy to prevent the abnormal strains of industry 
that cause the unnatural deterioration of the human factor 
in industr}". A wage worker may be permitted to sell his 
daily net fund of working power — his usance — but not his life. 

Among the principles in the labor section of the Versailles 
treaty are the following: "the adoption of an eight hours' day 
or a forty-eight hours' week as the standard to be aimed at 
where it has not already been attained," and "the adoption 
of a weekly rest of at least twenty-four hours, which should 
include Sunday whenever practicable." 

5 Published as "The Case for the Shorter Working Day," by the 
National Consumers' League; see especially pp. 621-892. 
"See Vol. T, pp. 13.5 and 197. 



368 WAGES AND LABOR [Pt. IV 

§ 9. Plan of the minimum wage. Even more recent than 
the legislative regulation of hours downward is the attempt 

to regulate wages upward in the case of certain low-paid wage 
workers. It is true that much public regulation of wages 
occurred in Europe before the end of the eighteenth century ; 
but in the main this was directed toward limiting the de- 
mands of the wageworkers, and in England its administration 
was in the hands of justices of the peace who were of the em- 
ploying class. The modern movement for the minimum wage 
began in Victoria in 1896, and it soon extended to nearly 
all the other Australasian states. Great Britain applied the 
plan in 1910 to industries in which wages were exceptionally 
low. The plan was first adopted in the United States by 
Massachusetts in the year 1912, though in an emasculated 
form, and spread so rapidly that at the end of 1919 it was 
found in fourteen states and in the District of Columbia. 
Minimum-wage laws usually lay down a "living wage" as 
the standard to be used, and they are known as "flat-rate" 
or "wage-board" laws, according as they prescribe a flat 
rate of wages or, as is more frequent, leave the decision in 
each case to a wage commission established to administer the 
law. 
^ At first glance the principles involved in the legislation 
' limiting hours and those in minimum-wage legislation may 
seem 'to be the same. But there is an important difference. 
In the former case the evil is that of a too long work- 
ing period, injurious to health, and this can be reached di- 
rectly and stopped by an efficiently administered law. But 
in the latter case the real evil is industrial weakness and in- 
capacity such that the workers are unable to command a 
"living wage" in a competitive market. A minimum-wage 
law, by itself, neither cures the industrial incapacity nor in- 
sures employment to the industrially weak at any wage. The 
law does not attempt to compel employers to employ at the 
legal minimum wage every one who wishes to work ; it merely 



Ch. 22] PUBLIC REQUISITION OF HOURS AND WAGES 3Gn 

declares that the emploj^er shall not employ any one whom, in 
his employ, he finds to be not worth so high a wage. 

§ 10. Wage theory in the minimum wage. In most 
discussions of the wages of women there is a ready 
confusion of sympathetic ideals of what one would like to see 
with the cold facts as they are. Women's services (espe- 
cially those of young women) have increasingly of late been 
coming upon the labor market in such a way as to cause 
abnormal congestion in a few occupations. Employers have 
not caused low wages in these cases. Partly these occupa- 
tions are the clean, light, and agreeable ones; partly they 
have a relative social glamour; largely they can be followed 
for a few years near the home of the worker; nearlj^ always 
they maj^ be undertaken with brief training and little skill. 
Investigation has shown that at least 80 per cent of this 
group of girl workers live at home. A wage that is a 
"living wage" when used as a pro-rata contribution to an 
American family income is frequently insufficient for the 
girl living ''independently." Such a girl is, under the con- 
ditions, unable to earn a living in her chosen occupation, and 
the minimum-wage law takes her need as the standard up to 
which must be raised the wages of the other four fifths. 

It may be better to deal with such individual cases as ap- 
pear among the one fifth of all girls employed than to apply 
governmental wage-fixing to the whole group. Unless the 
demand for a particular kind of service is absolutely in- 
elastic (a rare if not impossible situation in a large market), 
there must be fewer jobs for the less capable workers at high 
than at low wages, other prices remaining the same. Fur- 
ther, some of the less capable workers must be crowded out 
of such jobs as remain; for an artificially higher wage at- 
tracts into an occupation some from other occupations in which 
the pay before was higher. It seems to be admitted by the 
friends of minimum-wage legislation that this result is logi- 
cally to be expected, and that to some degree it appeai-s. Of 



370 WAGES AND LABOR [Pt. IV 

course, it is never possible to tell to just what extent workers 
have been and are being excluded in this way from any par- 
ticular establishment or occupation. Forbidden to earn what 
they can, the poorer workers must become dependent on 
charity. It may be said, and perhaps truly : better this than 
underpaid labor destructive to the health of the workers, and 
evil in its competitive effects upon other wage workers. 

§ 11. Limitations of the minimum wage. Generous 
sympathies have guided this movement, of which much has 
been hoped, and which, on the other hand, has always had its 
adverse critics. Its friends, after more than twenty years 
of experience, hardly claim more for it than that the 
''dire predictions" have not been verified. In truth, it would 
seem that the plan as yet has not been tried on a scale that 
could yield very large fruits either for good or for evil. The 
persons whom it is sought to aid are only selected groups of 
the lowest paid workers, generally limited to minors and 
young women, who in many cases are those of inunigrant fam- 
ilies in urban districts. A large volume of discussion on this 
subject has developed, mostly of an a priori nature, of which 
we may here touch only a few of the salient points. 

The one unquestioned service of the minimum-wage law is 
that of diagnosing the evil of low wages rather than in rem- 
edying it. The minimum-wage law brings to light the in- 
dustrial' incapacity of particular individuals to earn a living 
wage. Alongside of the abnormally low paid occupations or 
elsewhere in the industrial organization are other occupa- 
tions in which with, or often even without, special training, 
the sweated workers could get, competitively, more than the 
minimum wage if they could, or would, qualify for the work. 
More direct remedies would be to transfer workers to jobs 
in which they can get a living wage, to abolish the incapable 
workers or their incapacity by such methods as reg^ilating 
foreign or cityward immigration, custodial care of the physi- 
cally, mentally, and morally weak, vocational guidance, and 
more effective measures of industrial education. 



Cir. 22] PUBLIC REGULATION OF HOURS a:ND WAGES 371 

§ 12. Mediation and voluntary arbitration. The labor 
controversies in which the public has the largest interest as a 
third part}^ ^ are those that result or may result in strikes. 
The public interest becomes acute when a strike results in 
interference with the individual freedom of other workers and 
of non-participants, when it causes a blocking of the highways 
and disturbance of the peace, and when it prevents the regu- 
lar production and transportation of the commodities that 
the public consumes. The public, therefore, has steadily be- 
come more interested in all methods and agencies designed 
to conserve better relations between employers and wage 
workers, and to diminish or, if possible, to do away with 
strikes when individual and collective bargaining between the 
two parties fail. 

Mediation, or conciliation, is the effort of a third party to 
get the two parties to a trade dispute to come together to 
agree peaceably upon a settlement. Mediation may be volun- 
tarily undertaken in a particular case by any citizen or by a 
public official, usually the executive (mayor, governor, or 
President) ; or it may be by a regular public state or national 
commission charged with this duty (as in some seventeen 
states). 

Arbitration is the decision, by a disinterested person (or 
commission) to whom it is submitted, of the exact terms, after 
a provisional settlement of a dispute. It is voluntary when 
the parties agree in advance to accept the verdict, and com- 
pulsory when they are compelled by law to submit to arbitra- 
tion and abide by the verdict. 

Some provision either of voluntary private or of public 
agencies to mediate between the parties in labor disputes and 
to facilitate voluntary arbitration has been made of late in 
most communities of the civilized world, including thirty- 
two of our states. No one objects to them, and they ac- 
complish much good; but they fail oftenest in the greater 
emergencies because of the unwillingness of one or the other 

TSee § 16. 



372 WAGES AND LABOR [Pt. IV 

party to submit the case, or because of lack of any power 
to enforce the decisions. 

During the World War many plans of arbitration were 
devised in various countries. The most notable of these in 
America was the Federal War Labor Board to arbitrate in 
disputes between railroads and train operatives engaged in 
interstate commerce. Steps had earlier been taken in this 
direction, first by the act of 1888, then by the Erdman Act 
of 1898, superseded by the Newlands Act of 1913, and sup- 
plemented by measures for mediation by the Department 
of Labor. Under the Federal Control Act creating the Fed- 
eral Railway Administration for war purposes, a labor board 
exercised virtually absolute power. But, in the transporta- 
tion act (Esch-Cummins Act) of February 28, 1920, re- 
storing the railroads to private control, the voluntary prin- 
ciple was maintained. Provision was made for "Railroad 
Boards of Labor Adjustment " to be established by agreement 
between any carrier or group of carriers and employees; and 
for a supreme Railroad Labor Board of nine, three for each 
of the groups of management, labor, and public, with a 
central office at Chicago. If the decision of any of these 
boards is violated, apparently the utmost remedy of the Labor 
Board is to ''make public its decision in such manner as 
it may determine." Great Britain, by the Industrial Courts 
Act of 1919, has provided for a central court to be appointed 
by the Minister of Labor, and for such other courts of in- 
quiry as may be needed to take up particular labor disputes 
as they arise, on the principle of voluntary arbitration. 

§ 13. Compulsory arbitration. The serious question in 
the subject of arbitration concerns the introduction of the 
principle of coercion by government, in compulsory arbitra- 
tion. This, in principle, is pretty radically different from 
voluntary arbitration ; for, as it denies to the parties the right 
to settle their dispute by private agreement, it becomes in 
effect the legal regulation of rates of wages and. conditions 



Ch. 22] PUBLIC TJK(ilLATIOX OF HOURS AND WAGES 373 

of work. In principle tliis was involved in the rejijulation of 
wages in England from the fourteenth to the early part of the 
nineteenth centuries. The plan is approached in the indus- 
trial courts that are now provided in a number of European 
countries for a cheap and expeditious settlement of small dis- 
putes regarding trade matters, arising in the relations between 
employer and employees. 

The new^ modern development began when New Zealand 
passed a compulsory arbitration act in 1894, followed to 
some extent since by all the other Australasian states, 
largely through the action of the labor party. Through the 
operation of its act, New Zealand came to be called the 
"land without strikes," though the description w^as in- 
accurate, especially after 1907. The Canadian Industrial Dis- 
putes Act of 1907 is an example that has had influence upon 
public opinion everywhere, and has been followed to some 
extent in recent legislation in New Zealand, America, and 
elsewhere. It involves the compulsory principle in a limited 
degree, making it unlawful in public utilities and mines to 
change the terms of employment without thirty days' notice, 
or to strike or lockout until after investigation and hearing 
before a board to be nominated for the purpose. The Colo- 
rado Act of ]915 went even beyond the Canadian act in its 
scope. 

A notable experiment was undertaken when the Kansas 
legislature in January, 1920, established a Court of Indus- 
trial Relations. This court, in addition to the powers pre- 
viously held by the state Public Utilities Commission, was 
given other regulative powers in respect to wages, hours, and 
conditions of work in a number of industries affected with 
a public interest, including coal-mining and all public utili- 
ties. The individual w^orker is guaranteed freedom of action 
in making or terminating contracts, but the right to strike 
is denied in forbidding conspiracy to quit employment. The 
operation of this act, strongly denounced by organized labor, 



374 WAGES AND LABOR [Pt. IV 

is watched with great interest by the general public. The 
plan seems destined to have wider application and a larger 
development in the not distant future. 

§ 14. Organized labor's attitude toward labor legislation. 
Labor organizations hitherto have been in their legal nature 
almost entirely private and voluntary. They are seldom incor- 
porated and are rarely even recognized in any way by legisla- 
tures and by courts, which deal merely with the members 
as individuals.^ Their private character, combined with their 
limited membership as compared with the total population, 
leaves them without the power to accomplish legally by them- 
selves the results that they desire in their own interest. 
Hence they are tempted at times to usurp public authority 
over the field of private rights in industry.*' In other cases, 
when they have come to the end of their unaided powers, they 
invoke the aid of the law to accomplish their objects. But 
the appeal of organized labor to the law is special and quali- 
fied, being confined to cases where the actions of others are 
controlled to the advantage of the union, such as regulating 
the work of women and children, controlling the acts of em- 
ployers in respect to construction of factories, and limiting the 
length of trains. This does not imply a peculiarly selfish at- 
titude on the part of organized labor. Action together in any 
social group always develops in men their loyalty and spirit 
of cooperation without always making them more considerate 
to those outside of their group. Indeed, often men acting 
through their chosen officials, private or public, are more 
selfish collectively than they are individually. The leaders 
of any group of men, whether of wage workers, merchants, 
manufacturers, or political constituents, find it necessary to 
show that the interest of their supporters rather than a 
broader ** sentimentality" is uppermost in their thought. 

8 The few exceptions to this statement are mostly recent ; such as 
the recognition of the unions in New Zealand in 1894 as parties in the 
plan of compulsory arbitration, and in Great Britain in 1909 as agencies 
through which unemployment insurance may be administered. 

9 As appeared in ch. 21. 



Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 375 

And, further, the jealousy of any limitation of their power is 
as powerful a motive in one group of mfen as in another. 
All are made of the same human clay. But the stronger and 
more successful a labor organization is, the more vigorously 
do its leaders resist any legislation that limits the functions 
and field of action of the labor leaders, or that settles labor 
troubles in a way that makes the voluntary labor organization 
less necessary to the individual worker. Of course, self-help, 
as a spirit and as a policy, is a virtue, if it does not sacrifice 
the rights of others. But if the facts above suggested are 
borne in mind they will help to explain the otherwise often 
puzzling attitudes of organized labor toward different meas- 
ures of social legislation. 

§ 15. Organized labor's opposition to compulsory arbi- 
tration. Organized labor in America has attained to a highly 
influential position. On the whole, it constitutes an "aris- 
tocracy of labor," consisting largely of skilled workers who 
obtain a wage exceeding that of unskilled workers to a degree 
not seen anywhere else in the world. In this they have been 
favored by a combination of conditions which it is not pos- 
sible to describe briefly ; suffice it here to say that organization 
is itself not the whole explanation, but only a small part of 
it. That organized labor, officially, is strongly opposed to 
compulsory arbitration in America is thus perhaps sufficiently 
to be understood on the principle of "Let well enough alone." 
When, in August, 1916, a strike on the entire railroad system 
was threatened by the four railroad brotherhoods, and some 
action was proposed in the form of the Canadian act, the 
trade-union officials issued a statement containing these words : 
"Since the abolition of slavery no more effectual means has 
been devised for insuring the bondage of the workingman 
than the passage of compulsory investigation acts of the char- 
acter of the Canadian Industrial Disputes Act. ' ' Within less 
than a week the brotherhoods called off the strike after Con- 
gress had passed the much discussed Adamson Act giving 
the men the eight-hour day — a substantial part of what they 



376 WAGES AND LABOR [Pt. IV 

had asked — and providing for investigation, by a commission, 
of the effects of the rule. The decision was compulsory 
upon the railroads, but not upon the men to accept the 
terms. 

§ 16. The public and labor legislation. It has come to 
be recognized that in every serious labor dispute, especially 
in such as develop into strikes, those concerned are not merely 
the two parties, employers and employees, but a third 
party, the public, consisting of every one else whose inter- 
ests are not directly or indirectly bound up with one of the 
other two parties. The line of demarcation is not easy to 
draw exactly. An individual may be divided in sympathy, 
inclining to the one party perhaps because of some personal 
friendships or class loyalty, or to the other party because of 
material investments, while in the main having interests dis- 
tinct from either. But, wherever the public is drawn in as 
a party, it includes far more persons and embraces far 
larger interests than does either of the other two parties or 
than do both of them together. The public becomes a party 
primarily because it consists of the purchasers and consumers 
of the products, who are deprived of the usual supply of goods 
more or less essential to their welfare or even to their ex- 
istence. With the increasing division of labor and complexity 
of industrial organization, more and more kinds of business 
have, in a greater and greater degree, become ''affected with 
a public interest." The public becomes an unwilling party, 
therefore, in every serious labor controversy. 

In order that any kind of labor legislation shall be enacted, 
it is necessary (as far as we have a government by public 
opinion) for a majority of the public to be convinced that 
the conditions are such as call for governmental interfer- 
ence. It becomes so convinced in two broadly distinguish- 
able classes of cases: one, when the masses of unorganized 
workers are too weak to secure for themselves conditions of 
work and wages consistent with health and morality ; and the 
other, when strong bodies of organized workers, in their at- 



Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 377 

tempts to win their ends in an industrial dispute, exceed their 
private rights and invade the public welfare. 

§ 17. The public and compulsory arbitration. Where the 
railways are owned and operated by the state (as is now the 
case pretty generally except in America and Great Britain) 
the question of the "right to strike" arises from time to time 
in critical forms. The logic of the situation compels even 
those officials that are of the labor party or are most favorable 
to labor, to maintain an uninterrupted service on the public 
railways. The experiences of that nature in France and in 
Australasia have been notable. Nowhere in the United States 
has the principle of compulsory arbitration been adopted, but 
at the time of the great anthracite strike, in 1902, public senti- 
ment grew strong in favor of it. As a result of the intolerable 
conditions in the mines of Colorado, was passed the compulsory 
investigation act of 1915 in that state. In 1916 the threat 
of a general railroad strike brought from the public press 
almost unanimous condemnation of the strike as a method 
of settlement of wage disputes on the railroads. In the end, 
organized labor accepted, apparently with much satisfaction, 
a law involving the legal fixation of wages and the principle 
of compulsion as applied to the employers. President Roose- 
velt, at the time of labor trouble in the government printing 
office, maintained that employees of the government could 
not have the right to strike. Governor Coolidge (later Vice- 
President) upheld the same principle in the case of the po- 
licemen's strike in Boston in 1919. The trend of public 
opinion seems to be strongly to the same general conclusion. 
References. 

Abbott, Edith, Women in industry. N. Y. Appleton. 1915. 
Adams, T. 8. and Sumner, H. L., Labor problems. Chs. II, VIII, 

XII, sees. 1-4, 9, XIII, sec. 2. N. Y. Macmillan. 1914. 
Barnett, G. E., and McCabe, D. A., Mediation, investigation and ar- 
bitration of industrial disputes. N. Y. Appleton. 1916. 
Clark, V. 8., The labor movement in Australasia. N. Y. "" HolT 

1906. 
Commons, J. K., and associates, History of labor in the United States. 
2 vols. N. Y. Macmillan. 1918. 



378 WAGES AND LABOE [Pt. IV 

Commo'ns and Andrews, Principles of labor legislation. Chs. Ill, 

sees. 2, 3, IV, V. Rev. Ed. N. Y. Harper. 1920. 
Compton, W. M., Wage theories in industrial arbitration. A. E. 

Rev., 6: 324-342. 1916. 
Mote, G. H., Industrial arbitration. 1916. 
Suffern, A. E., Conciliation and arbitration in the coal industry of 

America. Bost. Houghton. 1915. 
United States Bureau of Labor Statistics, Bulletins on many subjects. 
Welb, Sidney, The economic theory of a legal minimum wage. J. 

P. E., 20: 973-998. 1912. 



CHAPTER 23 

OTHER PROTECTIVE LABOR AND SOCIAL 
LEGISLATION 

§ 1. Evils of early factory conditions. § 2. Improvement of factory 
conditions. § 3. Limitations of the wage contract. § 4. Usury laws. 
§ 5. Public inspection of standards and of foods. § 6. Charity, and 
control of vice. § 7. City growth and the housing problem. § 8. Good 
housing legislation. § 9. General grounds of this social legislation. 
§ 10. Training in the trades. § 11. Definition of unemployment. 
§ 12. Extent and evils of unemployment. § 13. Individual malad- 
justment of wages causing unemployment. § 15. Individual maladjust- 
ment in finding jobs. § 16. Public employment offices. § 17. Fluctua- 
tions of industry causing unemployment. § 18. Remedies for seasonal 
fluctuations. § 10. Reducing cyclical unemployment and its effects. 

§ 1. Evils of early factory conditions. The time is but 
brief in the life of nations since the main manufacturing: 
processes, now mostly conducted in great factories, were car- 
ried on in or near the homes of the workers. This change 
has been reflected in the meaning of "manufactures," which 
first meant literally goods made by hand, but now conveys 
the thought of goods made by machinery. The craftsmen 
worked alone in their own homes or with the help of their 
wives and children. If the master craftsmen had other help- 
ers, these were usually lodged and fed in the homes, and were 
taught by the side of the masters' own families. The old 
English law of master and servant was the labor law of that 
time, as, to some extent, it is to-day in Great Britain and 
America. The living and working conditions of the wage- 
workers were in general the same as those of the master him- 
self and of his own family; and this was the best possible 
guaranty that the conditions w.ould be kept up to the best 

379 



380 WAGES AND LABOR [Pt. IV 

standards of that time. The same change in industrial rela- 
tions that led^to the rise of the organized labor movement^ 
revealed new and often horrible neglect and evil in and about 

^ the factories. They had been erected with no thought of sani- 
tation, safety, and decency for the workers. 

§ 2. Improvement of factory conditions. Legislation to 
remedy these evils began in England a century ago, and the 
English code of factory laws, regulating the construction and 
operation of factories and providing for their inspection, has 
become voluminous. It has been copied, and in some respects 
improved, by all of the great industrial nations. This is true 
in American states in which manufacturing is largely de- 
veloped, though the states in which agriculture is the domi- 
nant industry still have very few such regulations. As a re- 
sult of these measures, accompanying and stimulating an en- 
lightenment of the employers' self-interest, there has been a 
very remarkable improvement in such matters in recent years. 
In many American factories erected in the last quarter-century 
the conditions as to lighting, heating, ventilation, stairways, 
fire-escapes, protection of the workers against accidents, and 
lavatory and sanitary arrangements are better than the best 
conditions ever existing in domestic manufactures. A some- 
what corresponding improvement has taken place on railroads, 
in mercantile establishments, and, perhaps less, in mining. 

y^ Factory legislation often has been opposed by employers 
because of the expense it causes ; but if the regulations apply 
to all factories, the expense becomes a part of the cost of 
production and is shifted, like the other expenses of produc- 
tion, to the general body of consumers, of which the employers 
form only a small part. Much of the recent progress in some 
establishments has, however, gone far beyond the require- 
ments of any existing laws. Many employers recognize that 
it is costly and unprofitable to themselves to allow their work- 
men to be in surroundings that reduce their vitality and 
efficiency. 

1 See ch. 21^ § 1. 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 3S1 

§ 3. Limitation of the wage contract. In general the law 
does not attempt to interfere with the making, by individuals, 
of such contracts as they choose to make. Its main function 
is to interpret and enforce the contracts that are made. But 
there has been an increasing group of exceptions to this gen- 
eral statement. It was forbidden even by the English com- 
mon law for wage workers under some conditions to sigii away 
their right to claim damages in case of accident, and many 
recent statutes have added more specific limitations in this re- 
spect.^ Legislatures and courts have been particularly watch- 
ful of the interests of children, who are usuallj' deemed in- 
capable of entering into contracts binding them to their in- 
jury. Sailors, likewise, have been somewhat exceptionally 
treated, because, journeying far from home, they are under 
the often despotic control of their employers. The English 
courts may even change the contract if the sailors have been 
coerced by their masters. 

Laws regulate the form, time, and methods of payment in 
manufactures and mining. Companies sometimes keep stores, 
and pay the workers in mines and factories in goods instead 
of money. Such a store in the hands of a philanthropic em- 
ployer might easily be made, without expense to himself, a 
great boon to his workmen, giving them the benefits of con- 
sumers' cooperation. But the usual result is told by the fact 
that such stores are often known as "truck stores" and 
"pluck-me-stores, " and heartily disliked by the wage workers. 
They are most often found where some one large corporation 
dominates in the community, as in a mining district, and the 
workers are in a very dependent condition. If the higher 
prices demanded practically lower real wages, it would seem 
that the worker had an immediate remedy in his power to de- 
mand higher money wages. Recognizing that tliis is for the 
most part an illusion — for it is in just such places that the 
conditions for free competition are least present — the law in 
many states prohibits these stores. It regulates also the meas- 

- See ch. 24, §§ 5-7, on the old law of employer's liability. 



382 WAGES AND LABOR [Pt. IV 

uring of work, fixing the size of screens and of cars used in 
coal-mining. The law is especially favorable to the hand- 
laborer in regard to the collection of his wages, requiring 
monthly or fortnightly or sometimes weekly payments. Me- 
chanics' liens give to workmen in the building trades the first 
claim upon the products of their labor. 

§ 4. Usury laws. The limitation by law of the rate of 
interest that may be charged affects many persons outside the 
ranks of wage workers. Usury laws are found almost univer- 
sally in civilized lands. By usury was formerly meant any 
payment for the loan of goods or money; now it means only 
excessive payments. In former times moralists and lawmak- 
ers were opposed to all usury or interest. The reason for this 
attitude is not hard to find.^ Most loans were made in times 
of distress. The sources of lendable capital and the chances 
of profitable investment were few. But for the last four cen- 
turies there has been on the question of usury a gradual 
change of opinion, beginning in the commercial centers and 
progressing most rapidly in the countries with the most de- 
veloped industry, A moderate rate of interest is now every- 
where permitted; but in all but a few communities the rate 
that can be collected is limited by law, and penalties more 
or less severe are imposed upon the usurious lender. 

Usury laws are practically evaded in a number of ways 
within, the letter of the law.* Many persons maintain that 
they do more harm than good even to the borrower, whom 
they are designed to protect. In a developed credit economy, 
where a regular money market exists, they are superfluous, to 
say the least, as most loans are made below the legal rate. 
Such laws, however, have a partial justification. In a small 
loan market they to some extent protect the weak borrower 
at the moment of distress from the rapacity of the would-be 
usurer. There has been great need to check the rapacity of 
the "loan-shark" in cities. Usury laws are fruits of the 

a See Vol. I, pp. 292-293. 
4 See Vol. 1, p. 304. 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 383 

social conscience, a recognition of the duty to protect the 
weaker citizen in the period of his direst need. Their utility 
is diminishing, and at best they are only negative in their 
action, preventing the needy borrower from borrowing when 
his need is acute. In many European countries a more posi- 
tive remedy has been found in the provision of public pawn- 
shops. In America a very little has yet been done in this 
way, and that mostly by private philanthropy.^ 

§ 5. Public inspection of standards and of foods. The 
determination and testing of standards of weights and meas- 
ures has long been a function of government. English laws 
of the Middle Ages forbade false measures and the sale of 
defective goods, and provided for the inspection of markets 
in the cities. Usually, the self-interest of the purchaser is 
the best means of insuring the quality of goods ; but personal 
inspection by each buyer frequently is difficult and time-con- 
suming, requiring special and unusual knowledge of the prod- 
ucts and special costly testing apparatus. The states and the 
nation undertake in some cases, therefore, to set minimum 
standards of quality, and to enforce them by governmental 
inspection. Government coinage had its origin in this need. 

This policy is applied, however, mainly to commodities af- 
fecting health ; its application to art products, except to pro- 
tect the morality of the community, would be difficult or un- 
wise. Recent legislation in many lands and in all of the 
American states has developed greatly the policy of insuring 
the purity or the safety of many articles consumed in the 
home; notable is the Federal Pure Food and Drug Act of 
1906. The federal law levying a tax on oleomargarine, how- 
ever, was designed as protective legislation in the interest 
of the farmer. Public regulation and inspection sometimes 
raises the price, but the cost is small compared with the con- 
venience and the benefits resulting to the citizen. 

§ 6. Charity, and control of vice. The public relief of 
the defective classes, insane, feeble-minded, and paupers, is 

5 See Vol. I, pp. 293 and 303. 



384 WAGES AND LABOR [Pt. IV 

a part of the social protective policy. The public interest 
undoubtedly is served by having these suffering classes sys- 
tematically relieved, but the extent and nature of the pro- 
vision are questions ever in debate. Still more debated is 
temperance legislation, both as to licensing and as to pro- 
hibiting the liquor traffic. Nowhere is the manufacture and 
sale of intoxicating liquor treated quite like the traffic in 
most other goods, because it is recognized that the public in- 
terest is affected in a different way. While it is beyond ques- 
tion that society should protect itself and its innocent mem- 
bers against the drunkard, it is more doubtful whether it owes 
to the man, for his sake, protection against his own blunders. 
Not even the gods can save the stupid. Temperance legis- ' 
lation is strongest in its social aspect. The opponent of it 
usually champions the individualist view ; its partizans uphold, 
in varying degrees, the social view. 

Similar questions arise regarding lotteries, gambling, bet- 
ting, and horse-racing. When a man backs a worthless horse 
against the field, money probably is transferred from the 
stupider to the shrewder party. The philosopher may say 
that the sooner a prodigal and his money are parted the bet- 
ter ; but the broken gambler remains a burden and a threat to 
honest society. Gambling, lotteries, and speculation cause em- 
bezzlement, crime, unhappy homes, and wrecked lives.^ Here 
are to, be found with difficulty the true boundaries between 
ethics and expediency. A busybody despotism may protect 
the fool, but it thereby helps to perpetuate and multiply his 
folly ; yet, if the fool is left alone, he too often is a plague to 
the wise and the virtuous. 

§ 7. City growth and the housing problem. In 1790, of 
our population only 3 per cent lived in cities of more than 
8000 inhabitants; in 1900 the percentage was 33. Then 
the largest city (Philadelphia) numbered 50,000; in 1910 the 
largest city (New York) numbered 5,500,000; that is, one 
hundred and ten times as large as the largest one hundred 

6 See ch. 12, § 2. 



Cn. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 385 

and twenty years before. The total number of persons liv- 
ing in cities of 8000 had increased in more than double that 
ratio. In 1920, for the first time, the population classed as 
urban (in places with 2500 population or more) exceeded that 
classed as rural, being 51.4 per cent of the total. 

The rapid growth of urban communities brought many evils. 
Considered in their more material aspects, nearly all of 
these are summed up in the term, "housing problem." 
As population grows denser in cities, land rises in value, 
yards and gardens narrow and then disappear, light, sun, 
and air are shut out, and cleanliness, decency, and home life 
become more difficult and, for many, impossible. The resi- 
dents gradually group themselves in districts corresponding 
to their economic incomes, and the poorer parts of the popu- 
lation become tenement dwellers in the neighborhood of fac- 
tories or become segregated in "slum" districts of unsani- 
tary and dilapidated houses. 

§ 8. Good housing- legislation. Two policies are open un- 
der these conditions. The one, always followed for a time, is 
to leave individual self-interest unguided to solve the prob- 
lem. If the tenant agrees to rent a disease-breeding house, he 
is the first to suffer. The interests of investors, it is said, will 
supply as good a house as each tenant can pay for. The 
other policy now adopted is to set a minimum standard of 
sanitation and comfort in respect to plans, lighting, materials, 
and proportion of lots to be covered, to which standard all 
builders and owners must attain. Complying with the legal 
requirements, they are left free to collect whatever rent they 
can get. As one bad building may bring down the rent of 
all on the street, such legislation may sometimes be in the 
interest of the body of landowners as against the selfish desires 
of some individuals. Mainly, however, the regulation is in 
the interest of the tenants and of society as a whole, and against 
the immediate interests of the landlords. The rents from 
slum property are threatened; hence the strong opposition 
always manifested against tenement-house legislation by some 



386 WAGES AND LABOR [Pt. IV 

landlords, architects, and contractors, who fight it as an inter- 
ference with their interests and as a confiscation of their prop- 
erty. It is not unlikely that good housing legislation has 
the effect of making rents too high for some poorer tenants 
and driving them into the country. But this result is not so 
undesirable. Moreover, the control and inspection of housing 
conditions has in a few states been made state- wide to reach 
even the "country slums," which lately have been recognized 
^to exist. Enlightened sentiment to-day favors efforts to de- 
stroy the breeding-places of disease, misery, and crime, no 
matter where they may be. 

Property-owners are in many communities limited as to 
height of buildings, appearance, and, by the zoning sj^stem, 
even the uses for which houses may be erected in any district. 
American cities have still much to learn in this regard from 
the example of many European cities, which have developed 
the art of city planning with wonderful results in beauty of 
landscape and of architecture, in practical economy for busi- 
ness, and in the health and welfare of the mass of the people. 

§ 9. General grounds of this social legislation. Why are 
not such matters as we have been discussing safely left to 
individuals? It is for the interest of eveiy one that his back 
yard should not be a place of noisome smells and disagreeable 
sights. But men are at times strangely obstinate, selfish, and 
neglectful, and through one man's fault a whole community 
may suffer. The refusal of one man to put a sewer in front 
of his house may block the improvement of a whole street. 
The heedlessness of one family may bring an epidemic upon 
an entire city. There must be a plan, and by law the will 
of the majority ,must be imposed upon the unsocial few. 
Where voluntary cooperation fails, compulsory cooperation 
often is necessary. Thus health laws, tax laws, and improve- 
ment laws regulate many of the acts of citizens, limit the use 
of property, and compel men to better social courses against 
their own wishes and judgments. 

All such laws as these are protective legislation, in that they 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 387 

depart from the rule of free trade taken in its broadest sense. 
It does not follow, however, that all these laws stand or fall 
together. The justification of such measures is limited and 
relative, and therefore of varjang strength. All protective 
measures are alike in that the free choice of one citizen is for- 
bidden by law in the supposed interest of some other citizen 
who is to be " protected. ' ' While the purpose of the tariff is 
economic and political, in a large majority of social laws the 
moral purpose is fundamental. It is the demand of humanity 
that competition be placed upon a higher plane. ]\Iost social 
legislation is to protect the weak from being forced into con- 
tracts or from living in conditions injurious to their welfare 
and happiness. The justification for these limitations upon 
the right of private property, upon the free choice of the 
individual, upon "free competition," must be found in the 
social result secured. The best test of social protective laws 
is their contribution to a higher independence and to a freer 
competition on a higher, more worthy, and more humane 
plane. 

§ 10. Training in the trades. Free elementary and sec- 
ondary education has become the all but unquestioned public 
policy in American commonwealtlis. The main motive 
for it has been the belief that education in books is a necessity 
for good citizenship in a republic. At the same time it has 
been thought that the training of the school would help the 
child to earn a living. This appears to have been true as long 
and as far as it was combined with, or supplemented by, indus- 
trial training on the farm, in the home, and through appren- 
ticeship in the manual trades, as once was so prevalent. But 
industrial conditions have changed. Most of the old-time 
education of the schools has now little relation to the industrial 
life of the great majority of the children, for few enter clerical 
or professional callings. Germany was the first nation to 
recognize the new educational need (in fact, never as urgent 
there as here) and to provide for systematic and eflBcient train- 
ing in all the industrial arts. Since the beginning of the cen- 



388 WAGES AND LABOR [Pt. IV 

tury the American public has been awaking to the needs of 
the situation. We appear to be on the eve of a great develop- 
ment in industrial training that will equip youth for more 
efficient life in business and in the home, either in rural or in 
urban conditions. 

§ 11, Definition of unemployment. Unemployment is the 
state of a wage worker for the time out of a job. But this 
definition needs to be further explained and limited if it is to 
be useful in the discussion of unemployment as an evil calling 
for social remedy. There must be set aside the cases where 
the lack of a job is due to one rest-day in seven and to legal 
holidays, a total of nearly sixty-five days in most American 
states ; to the worker 's being on strike ; to temporary sickness ; 
finally, and more difficult to distinguish, that due to con- 
tinued disability, physical, mental, or moral, to do the work 
up to an acceptable standard and to retain a job in the occu- 
pation chosen by the applicant. The first cannot be called 
a problem, and the others constitute the problems of strikes, 
of industrial sickness, and of the unemployable respectively. 

There still remain some unanswered questions, such, for ex- 
ample, as: whether in seasonal trades (e.g., teaching or the 
building trades) allowance should be made for normal vaca- 
tions and for slack times, not to be counted as unemployment ; 
and whether lack of work at one's principal occupation is ever 
or always unemployment, when the person is actually em- 
ployed or can get work at some lower paid employment. The 
more frequent answer to these questions is in the negative, 
but this in some cases is almost palpably absurd. Further 
study is necessary to work out a generally acceptable concept 
of unemployment. 

§ 12. Extent and evils of unemployment. In every coun- 
try and at all times where the wage system prevails, some 
wage workers, now more and now less, are "out of work" 
and unable to get it. The proportion that they constitute 
of all workers cannot, with the aid of any existing statistics, 
be exactly told, nor can exact comparisons be made between 



Cii. 2;{] PROTECTIVE LABOR AND SOCIAL LEGISLATION 389 

different countries. Of the magnitude, importance, and 
difficulty of this ' ' problem of the unemployed ' ' there is, how- 
ever, no question. It is greatest, speaking generally, in manu- 
facturing industries, though, among the various kinds, great 
differences in this respect appear. In 1900 the United States 
census reported that of all persons in gainful occupations 2.5 
per cent had been unemployed more than half the year, 8.8 
per cent from three to six months, and 11 per cent from one 
to three months, a total of 22.3 per cent more than one 
month.^ In 1911 in a large group (nearly all) of the manu- 
facturing industries, the minimum number of wage-earners 
employed (in January) was 13 per cent below the maxi- 
mum (in November) . In some the difference was much greater 
(e.g., 24 per cent in the iron industry, 63 per cent in the 
brick-and-tile industry). Statistics of unemployment among 
trade-unions in New York and Massachusetts indicate that 
the annual average of unemployment is between 12 and 15 
per cent. In some years upward of 10 per cent of all the 
working time of the wage earning population is lost by 
unemployment. A considerable part of the total in an or- 
dinary year may be set aside as ''normal" in the sense that 
it is allowed for in the wage- workers' plans.^ And a part 
of it may even be desirable. 

Yet there remains an inconceivable sum of suffering in 
the lives of the workers, and an enormous economic waste 
of productive energy not only for them but for the 
whole community. The irregularity, and occasionally the 
excessive duration, of these periods of unemployment 
too often makes unemplojanent not a beneficent vacation 
(comparable to shorter hours), but a period of tragic 

7 Great importance should not be attached to these figures for they con- 
tain errors resulting from the inexact notions of inexperienced enumer- 
ators as to what constitutes unemployment, and from the inclusion of all 
persons gainfully employed, whether self-employed or in professional, 
salaried, or wage-earning positions. 

8 See Vol. I, p. 207, on irregularity of emplojTuent as influencing 
wages, psychic income, and choice of employment. 



390 WAGES AND LABOR [Pt. IV 

anxiety, demoralizing and unfitting for return to work. Ir- 
regular work is generally recognized to be a greater cause of 
poverty and of actual pauperism than is a low wage regularly 
received. 

It is impossible for the industrially more fortunate per- 
sons and classes of the nation (excepting the few who have 
learned by personal adventures or by sympathetic study of 
the problem) to comprehend how inevitably unemployment 
and the fear of it shape the social theories as well as the 
industrial character of the propertyless workers. The edu- 
cated and the prosperous denounce with contempt mingled 
with inquietude the vagaries of the Industrial Workers 
of the World and the destructive doctrines of Utopian com- 
munists. Such ideas are attributed to ignorance, to natural 
perversity, or, still more often, to the influence of ignorant 
and dangerous leaders. But, as an employer who lived for 
months as a manual laborer, has said: ''To the worker the 
job is the axle of his entire world." It is "impossible to 
overstate the way in which the having of the job affects the 
whole circle of a man 's life ; all his thinkings, all his feelings, 
all his believings, all his attitudes and concepts and beliefs." 
"When we see men thinking 'queerly' or feeling ' queer ly' 
and embracing strange philosophies, ... we ought to put 
our first question mark against the circumstances of their 
job."'« 

§ 13. Individual maladjustments causing unemployment. 
The cause or causes of the evil must be ascertained before 
a remedy can be intelligently applied. At the outset the 
problem of unemployment must be clearly distinguished from 
that of over-population and low wages. It is essentially 
a problem of maladjustment of the labor supply. That is, 
there is, under static conditions, work for all to do at 
various rates of wages that would bring about a value equilib- 

9 Mr. Whiting Williams, formerly vice-president of the Hydraulic 
Pressed Steel Company, in an address, "The Job and Utopia." Bul- 
letin of the American Association for Labor Legislation, March, 1921. 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 391 

rium of services.^'' The maladjustments are either of an 
individual or of a general character affecting numerous in- 
dividuals. 

Individual maladjustment may be due to a mistake in 
choosing an occupation (e.g., through the vain a*mbition of one 
unfitted to be an artist, actor, lawyer, or teacher) ; or to failure 
to acquire by adequate training the necessary skill ; or to loss 
of capacity by accident, old age, or failure of mental or moral 
powers; in all of which cases the problem verges upon or be- 
comes that of the unemployable. The " can 't-works " and the 
''wont-works'' must be divided from the "want-works." If 
there is any remedy in such cases, it must be through reedu- 
cation, personal reform, or change of occupation. 

Many persons look upon this type of cases as almost wholly 
accounting for the problem of the unemployed. They are 
confirmed in this opinion by the fact that the out-of-work 
group in any trade at any time is, on the average, the least 
efficient group of workers in the trade. This results from 
selection by the employers. This selection is due to the rela- 
tive, not to the absolute, efficiency or inefficiency of workers, 
and must result whenever there are any discoverable economic 
differences in the workers (all things considered) that are 
employed at the same wage. This would continue even though 
the poorest workers were to raise their efficiency above that of 
the best men now retained. "Personal inefficiency" may ex- 
plain a chronic low wage or absolute unemployability in a par- 
ticular case, but it does not explain intermittent lack of work 
for those willing and able to work. Unemplojonent is a social 
problem and not merely an individual problem. 

§ 14. Maladjustment of wages causing unemployment. 
It seems highly probable that the artificial maintenance of a 
wage above the competitive, or value-equilibrium, rate of the 

10 On static, see Vol. I, ch. 32 ; on the scarcity of labor, see Vol. I, 
ch. 18, § 2 and references there; on value of services and wages see 
Vol. I, ch. 18, especially § 2, and ch. 19, especially § 7. See also, be- 
low, ch. 25, on pressure of population with immigration. 



392 WAGES AND LABOR [Pt. IV 

individual, whether this be done by sympathy, by custom, or 
by the action of trade-unions, must cause some maladjustment 
of workers in relation to available jobs, and thus increase 
unemployment. To doubt this is again to maintain the abso- 
lute inelasticity of the demand for labor with changes in its 
price.^^ If the true equilibrium wage in a certain industry 
were $3.00 a day, then a wage of $4.00 a day would at- 
tract to the trade more than enough workers to meet 
the demand for labor in normal periods (unless entry to the 
trade is controlled by monopoly power), and at length the 
losses from unemployment would balance the day -wages re- 
ceived in excess of the rate obtaining elsewhere for that quality 
of labor. Any artificial obstacles to change of occupation or 
to concessions in the kind of work done and in the rate of 
wages must operate to increase the maladjustment. This 
may, and doubtless often does, occur, and cause unemploy- 
ment which neutralizes, in greater or less degree, the appar- 
ent gain of h^igher day-wages obtained by monopoly power. 
The very inertia of wages, however, in new price situations'^ 
makes the wage workers resist vigorously wage reductions at 
times of unemployment. They know that if the wage rate is 
cut, it will not easily be raised again as times get better. 
Moreover, the difficulty here indicated is more particularly 
one occurring in static conditions, and is to be distinguished 
from 'the dynamic maladjustments next to be considered. 

§ 15. Individual maladjustment in finding- jobs. Another 
kind of individual maladjustment is the failure of the jobless 
man to connect with the manless job. A certain amount of 
this maladjustment must exist in the most stable industries 
and in the most settled industrial conditions. Fluctuations 
occur in the market demand for the products of various estab- 
lishments, requiring the taking on or laying off of some men. 
Fluctuations occur in the plans both of employers and of 
wage workers as a result of age, of removal for reasons more 

11 See ch. 21, § 9, on the minimum wage. 

12 See Vol. I, p. 223, on friction in the adjustment of wages. 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 393 

or less non-economie, of desire to change occupations, of vari- 
ations in health, and of countless other causes. The needs of 
the employer for a worker, and of the worker for a job, are 
mutual. To a large degree these various fluctuations are 
mutually compensator^-, workers going and coming, orders in- 
creasing here and decreasing there. Total jobs and total work- 
ers capable of filling the jobs are at any moment in normal 
times equal quantities, if they can be brought together, 
the wage being adjusted, like any market price, so as to 
equilibrate demand for and supply of labor.^^ But al- 
most everywhere is lacking a real labor market. The substi- 
tutes for it are largely ineffective: trade-union action, em- 
ployers' associations, "want ads," cards in shop-windows, 
weary walks from door to door, lines of waiting men outside 
of factories, private employment agencies. At their best the 
private employment agencies perform valuable services within 
limited fields, but they are uncoordinated and utterly inade- 
quate to meet the chief need, and at their worst they are the 
instruments of great abuses against the unemployed, 

§ 16. Public employment offices. Vigorous efforts to 
create local "free employment offices" or "labor exchanges" 
began in a nun:V>er of countries about 1895. The movement 
gained headway in the next ten years and has since steadily 
grown. In Germany the chief exchanges have been founded 
and conducted by the municipalities (while others have been 
controlled by the unions and by groups of employers) and 
have remained largely decentralized, though cooperating to 
some extent through voluntary state conferences of officials 
of the exchanges, and after 1915 required to report to the 
imperial statistical office. The general results were remark- 
ably good, although not completely satisfactory. In the 
revolution that marked the military collapse of Germany in 
November, 1918, the trade-unions got from the employers 
recognition of the principle of "parity" in the management 
of the offices of employment, along with recognition of the 

13 See Vol. I, especially chs. 7, 19, and 28. 



394 WAGES AND LABOR [Pt. IV 

unions, the eight-hour day, and various other claims that 
they long had urged. 

Every industrial country of Europe has done something to 
provide free labor markets. Great Britain, after some ex- 
experiment with a local system, established in 1909 the first 
national system of "labor exchanges." In America the move- 
ment is developing in three directions — through municipal, 
state, and federal offices. These united, in 1913, in an 
"American Association of Public Employment Offices." In 
1915 there were known to be ninety-nine state and city em- 
ployment offices distributed through thirty states, besides 
federal offices operated in eighteen cities in connection with 
the Bureau of Immigration. The federal service in the De- 
partment of Labor, the management of which had been much 
criticized, was brought to an end, just when most needed, in 
the midst of demobilization in 1919, by the failure of Con- 
gress to appropriate the necessary funds. The clearly recog- 
nized task is now to cooordinate these various agencies into 
an efficient national system, eliminating partizan politics and 
elevating the management of all branches to the plane of 
professional service. Through these agencies should be op- 
erated an industrial service analogous in function to the 
Weather Bureau, and reporting from day to day the pressure 
of demand and the prospects for labor in various parts of 
the cbuntry. The economic results of a complete, exclusivCj 
and efficient service of this kind would far exceed its cost to 
the community. ^ 

§ 17. Fluctuations of industry causing unemplojrment. 
Any one of the maladjustments in employment thus far con- 
sidered may occur at a given moment, in static conditions of 
industry. But there are also maladjustments resulting from 
more general industrial changes throughout a period of time. 
'The two main types of these are seasonal and cyclical changes, 
the one occurring within a year, and the other occurring within 
the longer period of the business cycle. At the downward 
swing of these seasonal and cyclical changes the number of 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 395 

would-be workers exceeds the number of jobs/* and the re- 
sulting unemployment is greatest when the minor and the 
major swings are both downward, about midwinter, in a 
period of industrial depression. Thus in 1893-94, and to a 
lessening degree in 1894-95, 1895-96, in 1907-08, and 1914r- 
15. The unemployment beginning with the onset of the 
crisis in the summer of 1920 grew almost steadily worse, even 
after the return of spring in 1921, as prices tobogganed 
swiftly to lower and lower levels, and business of nearly all 
kinds was reduced in volume. The railroads alone, in des- 
perate financial straits, discharged about 500,000 workers, 
and the total number of industrial unemployed in 
the nation was estimated to be from three to six millions. 

Of course, employment offices alone are no remedy for 
the exceptional difficulties of such times, and the individual, 
whether he be an unfortunate ''out-of-work" or a more fortu- 
nate well-wisher, feels helpless in the face of the overwhelming 
burden of distress. Such a situation is declared by the radical 
communists to spell the bankruptcy of the wage system ; while 
the most conservative students of the subject confess that this 
periodic chaos in the labor market is the strongest indictment 
of, and involves the gravest dangers to, the existing economic 
and social order. 

§ 18. Remedies for seasonal fluctuations. But of late 
there has been a growing hope that an answer may be found 
to this economic riddle of the Sphinx. A number of different 
measures are beiug experimentally tested and applied. Many 
years of effort will be required for the perfecting of these plans 
separately and collectively. Some of these plans may be here 
indicated, however, briefly. To remedy seasonal fluctuations 
within the establishments, (1) output may be regularized by 
taking orders in advance; (2) by producing various products 
successively in the same factory; (3) by overcoming weather 
conditions, as has been done successfully in brick- and tile- 
making, ditch-digging, and buildiiig operations; (4) by trans- 

14 See ch. 10, § <3 and § 7, on the industrial crisis. 



396 WAGES AND LABOK [Pt. IV 

ferring workers from one department of an establishment 
to another; (5) by improving the employment departments 
so as to build up a more stable force, thus reducing the great 
expense of ' ' hiring and firing ' ' and the loss through training 
"green hands"; (6) by varying the length of the working- 
day while keeping the same working force throughout the 
year; (7) hj cooperating with other industries to build up 
a regular working force and transferring it from one estab- 
lishment to another with seasonal changes. 

Of great aid in a number of these measures is a broader in- 
dustrial training for the workers, making them more able to 
change from one occupation to another. For this purpose 
every period of unemployment and of temporary shortening 
of the working-day ought to be used as a time for trade educa- 
tion, by the recently devised and successfully applied ''short- 
unit courses for wage-earners."^^ 

§ 19. Reducing cyclical unemployment and its effects. 
The maladjustments due to the movement of the business 
cycle are even more difficult to remedy completely, but will 
be diminished by every measure that helps to reduce the great 
financial fluctuations.^*' Further, many communities have al- 
ready begun to plan large public works more systematically so 
that they may be carried on mainly when private business is 
more slack. A comparatively small amount of such emer- 
gency, work would maintain the balance of employment for 
a large part of the less skilled workers. It has been estimated 
by Bowley, an English statistician, that in the United King- 
dom it would be necessary to set aside only 3 per cent 
of the annual expenditure for public works to be used 
additionally in years of industrial depression, in order to 
balance the wage loss at such times. This well-nigh in- 
credibly small proportion may be compared to that between 

15 See Bulletin of the United States Bureau of Labor Statistics, No. 
159 (April, 1915). 

16 See ch. 8, § 6, § 7; ch. 9, § 6, § 8; ch. 10, § 14, § 16; ch. 14, 
S 12. 



Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 397 

the weight of the gj^roscope and the car or ship to which it is 
applied. It is hardly to be doubted that hitherto, in America, 
public undertakings have been executed much more largely in 
periods of business prosperity, and have been diminished dur- 
ing "hard times," thus greatly accentuating the harmful 
swing of the labor demand. Finally, unemployment insur- 
ance, which has already been applied by parliamentary legis- 
lation in Great Britain to a group of nearly three million wage- 
workers, is an indispensable and highly hopeful measure of 
relief. The place of this in a general system of industrial in- 
surance will be indicated in the next chapter. 

References. 

Commons, J. R. and associates, History of labor in the United States. 

2 vols. N. Y. Macmillan. 1918. 
Commons and Andrews, Principles of labor legislation in the \]. S. 

Chs. VI, VII, IX. N. Y. Harper. 1920. 
Pigou, A. C, Unemployment. N. Y. Holt. 1914. 
Sumner, H. L., and Merritt, E. A., Child labor legislation in the 

United States. U. S. Children's Bureau. Supt. of Docs. 1915. 
United States Bureau of Labor Statistics, Bui. 159. 1915. 



CHAPTER 24 



SOCIAL INSURANCE 

§ 1. Purpose and meaning of social insurance. § 2. Increasing need 
of social insurance. § 3. The new era of social insurance. § 4. Fea- 
tures of social insurance. § 5. Historical roots of accident insurance. 
§ 6 Development of compensation for accidents. § 7. The compen- 
sation plan in America. § 8. Standards for a compensation law. § 9. 
Old-age and invalidity pensions. § 10. Life insurance for wage-earners. 
§ 11. Historical roots of health insurance. § 12. Need of health in- 
surance in America. § 13. Unemployment insurance. § 14. Need of 
ideals in social insurance. § 15. Insurance rather than penalty. § 16. 
The compulsory principle. § 17. State insurance and a unified system. 
§ 18. The contributory principle. 

§ 1. Purpose and meaning of social insurance. In im- 
portance surpassing at present any one of the various meas- 
ures on behalf of the wage-earning class that have thus far 
been considered is the remarkable development now under 
way of plans and agencies to provide insurance for the "com- 
mon man." Insurance means making some kind of provision 
out of present means, so as to reduce the injury and suffering 
that would result from a future mishap. Usually, likewise, it 
implies uniting with others to distribute the expense fairly over 
all in the group. Social insurance is the term most frequently 
applied to the various institutions and plans provided, more 
or less under the regulation of law, for the protection of the 
lower paid workers in most modern countries. The terms in- 
dustrial insurance and workingmen's insurance are likewise 
used. The principal types of events for which social insurance 
in its various branches provides are (1) accident; (2) in- 
capacitation (either by old age or by permanent failure of 
health within the normal working years); (3) death; (4) 

398 



Ch. 24] SOCIAL INSURANCE 399 

sickness; and (5) unemployment. The five types of insurance 
to provide indemnity in these cases are usually known as 
(1) accident insurance, (2) old-age and invalidity pensions, 
(3) life insurance, (4) health insurance, and (5) unemploy- 
ment insurance or out-of-work benefits. 

The direct aim of social insurance is not to prevent these 
mishaps (though that may be an indirect result), but it is to 
provide some financial indemnity for the economic loss and ex- 
pense involved in the mishap. The principal kinds of losses 
are two : first, medical expense, occasioned directly in caring 
for the sick or injured person, the expense of medical atten- 
tion, nursing, hospital care, drugs, and special apparatus such 
as crutches and glasses, and burial expenses; second, wages, 
the loss of income because of inability to work as a result of 
injury, of illness, or of permanent disability, or (in the case 
of life insurance) of the death of the bread-winner, or of 
want of employment. 

§ 2. Increasing need of social insurance. In various con- 
nections we have observed how the changes that have been oc- 
curring in modern times have increased the uncertainties of 
the industrial life and of the earning power of the mass of the 
workers.^ It should be further observed that in city condi- 
tions a working family does not have, as in agi'icultural con- 
ditions, the supplementary sources of income from garden, 
field, forest, and stream, and it is not so possible to use the 
earning power of children, of old people, and of the partially 
disabled. The faster working pace of factories, the 
increase of power-driven machinery, the rapid fluctuations 
of employment with changing fashions, inventions, shifts 
of population, and waves of industrial prosperity and 
depression, all have introduced new risks and problems 
into the worker's life. The increasing payment of wages in 
money, and the more temporary nature of employment of men 
in many kinds of factory work, have added to the problem. 
With these changes have come belatedly a growing interest in 

iSee ch. 10, § 7; ch. 21, § 1; ch. 23, §§ 10-19; and ch. 33, § 14. 



400 WAGES AND LABOR [Pt. IV 

the welfare of the mass of the workers and a growing sense of 
responsibility on the part of the public. 

There is an appalling mass of misfortune in the United 
States requiring social insurance for its relief, although satis- 
factory statistics of the various types of misfortune are still 
lacking. On the basis of the experience of private industrial 
insurance companies, it appears that there are not less than 
25,000 fatal industrial accidents yearly, and 700,000 injuries 
causing disability for more than four weeks, besides an enor- 
mous number of slighter injuries, many of them very pain- 
ful, disabling for a period from one day to four weeks. This 
means that the loss in life and bodily injuries in industry 
in the United States while the country was at war in 1917 
and 1918 was about equal to the like losses of our soldiers 
on the battle-field. 

As to loss of time due to illness, the experience of Ger- 
many shows an average of eight or nine days a year per 
worker, and investigations in America point to a very simi- 
lar figure. This, applied to those gainfully employed in 
America, would mean nearly 300,000,000 days of illness, or 
1,000,000 one-man working years, causing a loss estimated 
at $750,000,000 annually (but at present wage rates fully 
$1,000,000,000). 

It is estimated that one in eighteen of American wage work- 
ers attains the age of sixty-five with no financial provision for 
old age, aiid that about 1,250,000 persons above the age of 
sixty-five are dependent on their families or on charity, public 
or private, receiving $250,000,000 yearly. The losses and 
suffering to dependents due to the death of the bread-win- 
ner are partially accounted for by accidents, but no estimate 
of much value can now be made of the other cases. Some 
notion of the losses from unemployment has been given in 
discussing that subject in the preceding chapter. 

§ 3. The new era of social insurance. Some not insignifi- 
cant attempts to deal with these problems were made in the 
nineteenth century, but the new era of social insurance may 



1 



Ch. 24] SOCIAL INSURANCE 401 

be said to date from the message of the Emperor William 
to the German Reichstag in 1881, in which he said: 

We consider it our imperial duty to impress upon the Reichstag the 
necessity of furthering the welfare of the working-people. ... In order 
to realize these views, a bill for the insurance of workmen against 
industrial accidents will first of all be laid before you; after which a 
supplementary measure will be submitted, providing for a general or- 
ganization of industrial sick-relief insurance. Likewise, those who are 
disabled in consequence of old age or invalidity possess a well-founded 
claim to more relief on the part of the state than they have hitherto 
enjoyed. 

The program here outlined was carried out by the enact- 
ment between 1883 and 1889 of a series of laws which, taken 
together, constituted a pretty effective system of social insur- 
ance for the mass of wage workers in the German Empire. 
Later amendments extended and improved the various 
features of the plan, which served as an example to 
other countries. America has been the tardiest among 
all the industrial nations to undertake this kind of social 
reform. 

§ 4. Features of social insurance. The plans of social in- 
surance, in force in various countries, present a great variety 
of features combined in many ways. The main characteristics 
in which they may differ relate to (1) the element of com- 
pulsion, (2) contributions by the insured, (3) the nature of 
the insurance organization. 

Insurance may be voluntary or compulsory. It is voluntary 
when the state simply encourages the formation of insurance 
agencies, and perhaps contributes something to them, leaving 
it to the individuals to insure themselves as they choose, in 
mutual societies or in privately managed companies. In the 
case of accident insurance, however, there is often a semi- 
compulsion by which the employer is required to pay indem- 
nity to his workers according to fixed scales of compensation, 
but is left free to insure himself against this risk or not as he 
pleases, in which case it is still called voluntary insurance. 
Compulsory insurance is that which the state requires to be 



402 WAGES AND LABOR [Pt. IV 

provided by means of some mutual organization of the insured, 
or of the employers, or by the state. 
Nii Insurance may be contributory or non-contributory. It is 
on the contributory plan when the insured workers contribute 
something toward the premiums that provide the funds for 
eventual payment. It is non-contributory when the funds are 
provided either by the employers or by the state without any 
payments from the insured. 
S Insurance may be (a) in private companies, carrying on 
the business for profit; or (b) in mutual companies of work- 
ing men, or of employers insuring themselves against the cost 
of compensation in case of accident to their employees; or (c) 
in a state bureau, or fund, organized and conducted by gov- 
ernment. The state insurance is said to be competitive when 
private companies are permitted to sell insurance to em- 
ployers, and exclusive when all the policies are issued by 
the state bureau. 

§ 5. Historical roots of accident insurance. The different 
kinds of social insurance had different origins, some knowledge 
of which is necessary to an understanding of the present situa- 
tion. These origins still affect the nature of social insurance 
to-day, and have prevented the development of a truly unified 
and logical system in accord with present conceptions of needs 
and of justice. 

Accident insurance had its beginnings in the liability of 
employers -for accidents that happened as a result of the em- 
ploj^er's negligence, a principle found to some degree in 
the law of all countries. Thus the earlier payments to work- 
ers in cases of accidents were not insurance indemnity, but 
merely damages collected in court for the fault of the em- 
ployer. In Great Britain and the United States, indeed, by 
judicial interpretation the law grew more strict as against 
the claims of the workers, until about 1880 in Great Britain 
and 1910 in the United States. To collect damages it was 
not enough for the workman to prove the employer's negli- 
gence, for collection was made more difficult by (1) the doc- 



Ch. 24] SOCIAL INSURANCE 403 

trine of contributory negligence, (2) the doctrine of the as- 
sumption of risk, and (3) the fellow-servant doctrine. 

By the doctrine of contributory negligence, the workman 's 
claim could be defeated by showing that he had by his care- 
lessness contributed to the accident even when the employer 
had been negligent. By the doctrine of assumption of risk 
the workman was presumed, in entering upon employment, 
to have taken upon himself the risks usually incident to the 
employment, including the chance of imperfections in the ma- 
chinery, of which he might by some care have known. By 
the fellow-servant doctrine the employer was freed from re- 
sponsibility for accidents due to the negligence of other em- 
ployees, "fellow servants," even when it was impossible for 
him to know their character and reputation, as in the case of a 
large factory or of a great railroad. 

§ 6. Development of compensation for accidents. In 
some countries of continental Europe, notably Germany and 
France, the law of employers' liability was altered in favor 
of the worker early in the nineteenth century, so as to make 
compensation more usual and adequate. Since 1885, espe- 
cially, this liability has been much further extended in many 
countries and in various directions, and yet the laws of acci- 
dent compensation still retain many features of the old lia- 
bility laws and remain in their legal character somewhat apart 
from the other branches of social insurance. Even in the 
newer type of "compensation" laws the indemnity paid by 
employers on account of accident is looked upon as commuted 
damages, but the old employers' defenses, just named, are 
abolished or made more difficult to plead. The new plan has 
the advantages of granting compensation by a schedule fixed 
in the law, insuring greater certainty, more adequate pay- 
ments, greater ease of securing redress, and abolishing the 
cost of law-suits. Still, in most countries and in most states 
in America, the worker has the option of suing under the old 
law. In some forty countries the principle of compensation 
by a prearranged schedule of rates has to some degree re- 



404 WAGES AND LABOR [Px. IV 

placed that of litigation and determination by the jury of the 
damages in each separate case. The insurance spoken of in 
relation to accidents is technically that which the employers 
may or must take to protect themselves against loss, not that 
which the workman has. 

The situation as to compensation in a few leading countries 
is as follows, the dates given being those of important legisla- 
tion. ■ . _, __; ;'^ Jj "I'; 

Accident Insurance 
Voluntary (as to employers insuring, but compulsory compensation). 
Great Britain, 1897, 1906, 1907. 

France, 1898, 1907, (compulsory for seamen, 1898, 1905). 
Denmark, 1898, 1908. 
Belgium, 1903 (voluntary except for miners). 

Compulsory insurance of their risks, by employers. 
Belgium, for miners, 1868. 
Germany, 1884 (in employers' associations), 1887, 1900, 1911 

( voluntary for some classes ) . 
Austria, 1887 (as in Germany), 1894 (voluntary for some classes). 
Norway, 1894 (in a state central insurance office), 1896. 
Italy, 1898, 1904. 

Holland, 1901 (in the Royal Bank or in private companies). 
Sweden, 1901 (as in Norway). 

§ 7. The compensation plan in America. Under the 
practical operation of the law of employers' liability in force 
in any American state until 1911, a very small proportion of 
the workers injured while at work were legally entitled to 
any indemnity, and a still smaller proportion could succeed 
in recovering any substantial amount. Employers, and the 
accident companies with which employers insured, either com- 
promised the claims for small amounts or fought in the 
courts the claims of those who refused to compromise. If 
the court awarded damages, large or small, a large part of 
the proceeds went for legal expenses. Only a small pro- 
portion of the total costs to employers went as benefits to the 
victims of accidents. It appeared, in an extensive investi- 



Ch. 24] 



SOCIAL INSURANCE 



405 



gation of the business of the large industrial insurance com- 
ponies, that but 28 per cent of the premiums paid by em- 
ployers were paid to workmen as indemnity. 

Between 1911 and 1921 the laws have been changed to some 
extent in their application to selected occupations in at least 
forty-three states and territories of continental United States, 
(covering all but five of the southeastern states, which are 
distinctly agricultural). Seventeen states had, in 1921, state 



WORKMEN'S COMPENSATION LAWS-1921 

(Revised to May Isl) 




K^^ Uo CompensaHon L^vs 

I I Compensalion Law, but no Slate Fund 

I I Comp^nsahon Law, wiih S\d\e Fund 



Fig. 1, Chapter 24. — Workmen's compensation laws in U. S. and 
Canada, 1921. Adapted from the map published by the American 
Association for Labor Legislation. 



insurance funds, and in six states (Nevada, Ohio, Oregon, 
Washington, West Virginia, and Wyoming) they Avere the 
only insurance agencies allowed. This remarkable develop- 
ment has been largely actuated and guided by a compara- 
tively small group of socialh' minded non-working-class 
citizens rather than by either employees or organized workers. 
It is an encouraging example of what can be done by skil- 



406 WAGES AND LABOR [Pt. IV 

ful methods, when conditions are ripe, in furthering righteous 
social legislation without the use of money or of corrupting 
influences. 

§ 8. Standards for a compensation law. The standards 
which, in detail, in one jurisdiction or another, have already 
been attained, and which are the provisional ideals now sought 
by reformers, may be briefly stated as follows. All employ- 
ments should be included, although as yet there are various 
exceptions, such as farm labor and domestic service, employers, 
with but few employees (the number excepted being from one 
to five), and non-hazardous employments. Compensation 
should be granted for all injuries, suffered in the course of 
employment, that causa disability beyond a definite waiting 
period of from three to seven days. Compensation should in- 
clude medical attendance for a limited period, and two thirds 
of the estimated loss of wages for disability, either total or 
partial, during its continuance ; and, in case of death, funeral 
expenses, and from one to two thirds of the estimated wages 
to the widow (or dependent widower) and children, or to 
other dependent relatives. To secure the full benefit of the 
plan it must be made the exclusive remedy, replacing entirely 
the old remedy of suits for negligence. The employer should 
be required to insure his risk, and general sentiment is mov- 
ing rapidly toward the plan of a state insurance bureau as the 
exclusive agency. For the administration of the system, an 
accident and insurance board should be created in each juris- 
diction. Experience shows the importance of careful atten- 
tion to numerous other details, and many amendments will 
be made as the needs become manifest in practice. 

§ 9. Old-age and invalidity pensions. Insurance to pro- 
vide pensions for old-age and permanent (partial or total) 
disability is in nature but an extension of the insurance 
against accident and sickness. In a relatively small num- 
ber of cases accidents result in permanent disability, and it 
is both illogical and inhumane to limit, arbitrarily, the com- 
pensation in such cases to a certain period, as two or three 



Ch. 24] SOCIAL INSURANCE 407 

years, as is done in many compensation laws. The disability 
due' to advancing years is in nature a chronic illness, in- 
evitable, sooner or later, to all who survive. The movement 
to provide some indemnity in such cases has been rapid in 
European countries, doubtless because the problem was a very 
pressing one where the average earnings are low. In Ger- 
many and Austria this development has been more in con- 
nection with other forms of insurance ; in Denmark, Great 
Britain, and France it has had more the aspect of an exten- 
sion of poor relief. In the United States little has been done 
to provide for these great needs. Massachusetts in 1907 au- 
thorized savings banks to sell insurance and old-age pensions 
to those who applied. An increasing number of corporations, 
especially railroads, are adopting a pension system for men 
growing old in their service ; but nothing had been done of a 
general public nature toward compulsory and universal pro- 
tection against these misfortunes until the enactment of the 
federal law, in 1920, establishing compulsory contributory 
old-age and invalidity insurance for the employees in the 
classified civil service, now half a million in number. 

The following table shows the situation in some of the 
leading countries: 

Old-Age and Invalidity Pensions 

Voluntary. 

Belgium, 1850, 1903 (voluntary except for miners). 
Italy, 1898, 1907 (all wage-earners). 

Compulsory. 

Belgium, for miners, 1868. 

Germany, 1889, 1899, 1911. 

Austria, 1889 (miners only); 1900 (office employees). 

Denmark, 1891, 1908 (non-contributory). 

France, for seamen, 1850, 1881; for miners, 1894, 1905, 1907 (non- 
contributory, all indigent citizens) ; 1910 (contributory, all workmen 
and employees; was voluntary by laws, 1850, 1886). 

Great Britain, 1908 (non-contributary, old-age pensions, granted by 
the government ) . 

Sweden, 1913 (universal, contributory). 



408 WAGES AND LABOR [Pt. IV 

§ 10. Life insurance for wage-earners. Life insurance 
for salaried men and the higher paid wage-earners is pro- 
vided in many cases by the regular reserve companies, but 
only a small proportion of the fifteen million "ordinary poli- 
cies ' ' in force touch the mass of the wage workers. The assess- 
ment companies (including fraternal orders), with something 
like nine million certificates in force and collecting about 
$150,000,000 annually from members, likewise serve mainly 
either the elite of the wage workers or the farmers and the 
business men of the small communities. But the greatest 
increase of life insurance for wage-earners has come of late 
in the form of "industrial policies" (for less than $1000 
each), of which (in 1919) there were forty-four million in 
force, three times the number of "ordinary" policies. The 
premiums received were $225,000,000, of which $181,000,000 
were either paid to policyholders or added to reserves (ulti- 
mately for the benefit of policyholders) . There are, of course, 
a good many cases (the number undeterminable) in which 
two or more of these assessment and industrial policies are 
held by one insured person, and many other cases where the 
insured is a minor. But the figures show, nevertheless, that 
provision of a minimum of life insurance is becoming well- 
nigh universal among wage-earners. This result, surely de- 
sirable, is due in large part tw the active efforts of solicitors 
of the companies working on commission. The cost of doing 
business, 'or deduction (about 20 per cent) from premiums 
paid, is perhaps not too much to pay for this educational 
work in the formative period of popular insurance experi- 
ence. Less gratifying is the thought that these policies pro- 
vide in most cases quite insufficient indemnities for the sur- 
viving members of the family, the proceeds frequently be- 
ing barely sufficient for funeral expenses ("grave-yard in- 
surance"), and in the great majority of other cases the meager 
proceeds quickly disappear, unwisely invested or foolishly 
spent, leaving the family quite unprovided for. 



Cu. 24] SOCIAL INSURANCE 40n 

All admirable plan that is making: ven- rapid progress is 
"group insurance," issued by the regular companies to in- 
dustrial establishments, covering all the persons in their 
employ during the year. In 1919 there were more than six 
thousand of these group contracts in force. This is but one 
of the ways in which private employers are now increasingly 
providing insurance for the survivors in the families of their 
employees. The ideal to be looked toward is a general plan 
that will make possible universal and adequate life insurance 
for all income-earning members of the communit3^- 

§ 11. Historical roots of health insurance. Health insur- 
ance (called also sickness insurance) had its origin partly in 
trade-unions and in fraternal societies voluntarily organized 
by workers, and partly in the system of public poor relief. 
The voluntary societies were first recognized, regulated, and 
encouraged by law (in some cases being given state subsidies), 
and later, in some cases, being made compulsory for some 
classes of members (i.e., such as miners and seamen). On 
these institutions have been built the later state systems 
of social health insurance. This movement had made great 
headway by the end of the third quarter of the nineteenth 
century in various European countries. The two systems 
that are the most typical and influential examples are those 
of the German Empire and of Great Britain, the former 
local and the latter national in organization. The British 
plan of national health insurance promises to be, on the 
whole, of the greatest influence upon American opinion and 
policy. However, the best informed American students favor 
in some features the more decentralized German system, as 
fitting our conditions rather better than the' centralized 
British system. While it is impossible to describe here the 
various systems in detail, the situation in the leading indus- 
trial countries of Europe may be indicated as follows. 

2 This subject should be studied in connection with the general 
principle of insurance set forth in chs. 12 and 13. 



410 WAGES AND LABOE [Pt. IV 

Heai-th Insubance 
VoliMitary. 
France, 1850, 1898 (voluntary except for miners). 
Belgium, 1851, 1894. 
Italy, 1886. 
Sweden, 1891. 
Denmark, 1892. 
Holland (authorized private societies and poor relief). 

Compulsory. 

Germany, 1883, 1911 (voluntary for others with earnings of $500). 

Austria, 1888 (voluntary for some classes). 

France, for miners, 1894. 

Norway, 1909. 

Great Britain, national system 1911 (was voluntary 1875-1911). 

§ 12. Need of health insurance in America. Contrary to 
the usual opinion in America, the sickness insurance in Ger- 
many is, both in amount of contributions collected and in im- 
portance to the welfare of the workers and their families, of 
more importance than is either accident compensation or the 
system of invalidity pensions. Yet, thus far, our interest 
and efforts in America have been directed almost entirely 
toward the reform of accident compensation, and almost every- 
thing remains to be done in the matter of social insurance 
against sickness. It is true that in recent years there has 
been a rapid development, in some of the larger cities, of 
medical insurance clubs conducted by private companies, with 
dues of ten cents weekly. They give medical care in ordinary 
cases, but require extra payments for surgical treatment and 
for medical supplies. They as yet touch only the outer 
fringe of the problem; but they testify to the need and to 
the increasing desire of the wage workers for insurance of 
this kind. It is believed that at least 4 per cent of the income 
of wage workers now is expended for the care of sickness 
and for burial insurance. The losses of wages meantime re- 
main unequalized by insurance indemnities. An Illinois 
commission reported in 1919 that the loss in wages and medi- 
cal bills averaged 5^ per cent or more of the family incomes. 



Cir. 24] SOCIAL INSURANCE 411 

A large proportion of the eases of temporary destitution in 
ordinary self-supporting families is due to sickness, at least 25 
per cent, as shown hy various investigations. The German ex- 
perience shows that 4 per cent of wages, collected in part from 
employers and in part from wage workers, is sufficient to give 
a far better medical service than can be had through private 
effort, to give some indemnity for loss of wages, and to 
carry on a very useful hygienic work for the families and for 
the public health. 

§ 13. Unemployment insurance. The most difficult of all 
the problems of social insurance is that of unemployment. 
There the amount of the risk in most cases is largely de- 
pendent on the personal qualities of the worker. There are 
obvious objections to making the competent, steady, sober 
members of any trade pay the penalty for the faults of 
their fellows. But, on the other hand, as we have seen,^ a 
large part of the problem of unemployment is charge- 
able to social maladjustments rather than to individual 
faults. 

At present, development in this field is along two lines, 
that of subsidized trade-union relief (the Ghent system), and 
that of compulsory state insurance in certain industries. By 
the Ghent plan the public pays a certain proportion (from 
one sixth to one half) of the amounts of the benefits paid by 
the unions or other associations. This plan, originating in 
Belgium, had been adopted before 1914 in many cities and 
by some countries in Europe, and in the war period was ex- 
tended to other countries. Great Britain is the first country 
to adopt a compulsory state system, and it virtually incor- 
porated the Ghent system by providing for grants out of 
state funds to associations that grant out-of-work benefits. 
It began operation in 1912, and applied to 2,500,000 per- 
sons, or one sixth of all the wage-earners. The contribu- 
tions are made as follows : % by employers, % by wage-earn- 

3Ch. 23, §§ 12-19. 



412 WAGES AND LABOR [Pt. IV 

ers, and % by the state. The application of the law was ex- 
tended in 1916 to workmen engaged in any of the war indus- 
tries. There are several original and interesting features of 
the act, such as rewarding, by the refunding of dues, those 
employers who provide regular employment, and older work- 
men who have received benefits amounting to less than their 
contributions. Its administration in close connection with 
the labor exchanges is giving valuable experience in this 
field. The working out of the many minor problems of clas- 
sification, assessment, and administration of unemployment 
insurance will require many years of experimentation. 

§ 14. Need of ideals in social insurance. The world has 
had forty years of experimentation of a remarkably 
varied kind in the field of social insurance, since the German 
system was inaugurated in the eighties of the nineteenth cen- 
tury. America stands almost at the beginning of a develop- 
ment along those lines that is certain to be of enormous ex- 
tent and importance. It would be folly for us to repeat the 
costly errors of other countries by failing to recognize certain 
principles that have been clearly established by experience. 
If these could be grasped and firmly kept in mind, our prog- 
ress in this field in America would be faster, more certain, 
less costly, and farther reaching than it promises otherwise 
to be. We can here attempt no more than merely to outline 
these principles that must be embodied in an ideal system of 
social insurance in America. 

§ 15. Insurance rather than penalty. The principle of 
social insurance rather than that of legal penalty should be 
universally recognized. At present, in all countries where 
the several kinds of insurance are found side by side, accidents 
are indemnified on plans that are still rooted in the notion 
of employers' liability for negligence; whereas, necessarily, 
the indemnity in case of sickness and of old age has no such 
explanation. The unfortunate result of this difference of view 
is that, whereas all cases of sickness and invalidity entitle to 
benefits, only those accidents suffered ''in the course of em- 



Ch. 24] SOCIAL INSURANCE 413 

ployment ' ' are indemnified, and the worker is left unprotected 
in a large share of the accidents to which he is liable. The 
worker's need and the social need are thus not adequately 
met. We have started along the same line of development 
in America, and it is to be feared that only through a long 
series of legal fictions and contradictory judicial decisions 
shall we be able to work out toward the practical need in this 
matter. Another unfortunate result of this difference is that 
accident compensation, being made peculiarly the task of the 
employers, does not develop the spirit of responsibility on the 
part of the workers and of cooperation between them and em- 
ployers that other forms of insurance call forth, where repre- 
sentatives of both parties sit together in the administration 
of the system. 

§ 16. The compulsory principle. Insurance must be gen- 
eral in its application to all the persons within broad wage- 
earning classes, and in order to be general it must necessarily 
be compulsory, not voluntary, in its application. To leave 
any form of insurance optional or elective, with either em- 
ployers or wage workers, is to fail of the main purpose in a 
large proportion of the individual cases where it is most 
needed, and to increase the expense to those that are included. 
Within a compulsory system, however, there should be given 
wide opportunity for the voluntary principle by admitting to 
the system others that are not compelled to insure, and to 
enable any insured person to increase his paid-up, non-forfeit- 
able insurance at any time by extra payments made at times 
of unusually high wages, from legacies, or from any other 
exceptional income. 

§ 17. State insurance and a unified system. The state, 
through the public insurance office, must ultimately be the 
sole agency for social insurance. Only in this way can the 
maximum of simplicity and economy be attained. Experi- 
ence thus far has shown the much greater economy (among 
other advantages) of giving to the state fund a monopoly of 
compensation insurance: the ratio of management expense 



414 WAGES AND LABOR [Pt. IV 

to premiums in commercial stock insurance companies is 35-40 
per cent, in competitive state funds 6-9 per cent, and in the 
Ohio state fund (exclusive) 1.6 per cent. However, state 
management calls for a better appreciation of expert training 
and a broader sentiment in favor of the merit system in the 
public service than is frequently found in America. 

There should be a unification of various kinds of insurance 
in one general plan and under one general administration for 
the whole state. This should be done with full regard to the 
actuarial differences in costs as among various kinds of in- 
surance, various trades, various establishments, and, to some 
extent, even the various individuals, so as to ascertain the 
costs and ' to distribute them equitably. Only in this way 
can provision be made for entire mobility of labor, so that 
men may not be bound, as a condition for obtaining bene- 
fits, to continue in the service of any one employer. To 
this end there should be interstate comity and cooperation, 
so that the insured could at any time transfer his actuarial 
equity from one state to another. 

§ 18. The contributory principle. The contributory prin- 
ciple should be adopted, employers and wage-earners 
contributing to the cost in equal amounts. But, further, 
the general public interests may be recognized through the 
payments in aid of the funds (subsidies, subventions). Both 
employers and employees usually seek to escape the burden 
by getting the state to bear the whole expense * or by getting 
the other party to pay all or the larger part. But it is much 
to be desired that in large part the finances of a system of 
social insurance should be disassociated from the ordinary 
budgetary system of taxation and public expenditures. The 
fundamental reason why the premiums should be divided be- 
tween employers and employees is that this is most favorable 
to the equal participation and cooperative efforts toward re- 
ducing the risk, and developing right industrial and political 
4 See examples in the lists of laws above cited, § 11, 



Cn. 24] SOCIAL INSURANCE 413 

relations. Eveiywhere it is the practice to provide for rep- 
resentation nearly in proportion to contributions. 

It is usually assumed by employers, by wage Avorkers, andr' 
by others in the discussion of the subject, that the burden 
remains and is borne by those who directly pay the premi- 
ums, and just in proportion to their payments. This is an 
almost utterly mistaken view. There is, on the contrary, 
every reason to believe that the general principles of shifting 
and incidence of taxation apply fully here.^ Wages are not 
arbitrarily fixed; they result, as we must believe, from an 
adjustment and equilibrium of the various classes of labor 
in a general economic situation; therefore, after a time, com- 
pulsory insurance premiums become a part of that general 
situation. If premiums are paid by employers (by all, with- 
out exception) they will ultimately result in lower wages, 
and if paid by the workmen will ultimately result in higher 
wages than if paid by the other party. Of course, there is 
some delay and friction in making the adjustment;, but, under 
any settled policy, the adjustment, once made, will be main- 
tained. 

The true benefit of social insurance to workingmen is not 
that their wages are increased by the direct contributions of 
employers to the premiums, though there are doubtless some 
cases of "parasitic" industries and parasitic employers that 
now escape their due share of payments for risk, that would 
have to pay more to cover these risks under an insur- 
ance system. The great benefits are that total wages and 
losses are apportioned economically to the points of maximum 
utility; that accumulation of capital by and for the wage 
workers is made regular, automatic, safe, and in great 
amounts ; and that financial aid, physical care, and mental re- 
lief from some of the most tragic anxieties of life are given 
effectively and economically to the masses of the people. 

But, as has been indicated in another connection above, it 

5 See ch. 16, § 14. 



416 WAGES AND LABOR [Pt. IV 

is far from being a matter of indifference, psychologically, 
where the first, immediate burden of premium payment falls. 
The persons paying the premiums, in whole or in part, are 
far more keenly aware of the cost, and alive to reducing and 
removing the evil conditions. Moreover, their interest is 
stimulated by the fact that they are the first to gain by any 
temporary economies, and the more so because of the illusory 
belief, sure to persist, that they are the ultimate as well as 
the immediate bearers of the costs. 

The development of a complete system of social insurance 
along these lines promises to do more than any other single 
measure of practical social reform now under consideration 
to change the conditions and the outlook of the wage-earning 
class. 

References. 

Adams, T. S., and Sumner, H. L., Labor problems. Ch. XII, sees. 

6-8. N. Y. Macmillan. 1914. 
ComTrwns, J. R., and associates, History of labor in the United 

States. 2 vols. N. Y. Macmillan. 1918. 
Commons and Andrews, Principles of labor legislation in the U. S. 

Ch. VIIL N. Y. Harper. 1920. 
Fo^rster, R. F., The British national insurance act. Q. J. E., 26. 

275-312. 1911-1912. 
Frankel, L. K., and Dawson, M. M., Workingmen's insurance m 

Europe. Charities pub. com. 1910. 
Henderson, C. R., Industrial insurance in the United States. Univ. 

of Chic. Press. 1909. 
Lewis, F. W., State insurance. Bost. Houghton. 1909. 
Miller, G. R., Social insurance in the United States. N. Y. Mc- 

Clurg. 1918. 
Rubinow, I. M., Standards of health insurance. Spectater Co. 

1915. 
United States Bureau of Labor, Annual reports, 1908, 1909. 
Warren, B. S., and Sydenstricker, Edgar, Health insurance. U. S. 

Pub. Health Supt. of Docs. 1916. 



CHAPTER 25 



POPULATION AND IMMIGRATION 



§ 1. Nature of the population problem. § 2. Complexity of race 
problems. § 3. Economic aspects of the negro problem. § 4. Favor- 
able economic aspects of earlier immigration. § 5. Employers' gains 
from immigration. § 6. Pressure of immigration upon native wage- 
workers. § 7. Abnormal labor conditions resulting from immigration. 
§ 8. Popular theory of immigrant competition. § 9. Divergent views 
of effects on population. § 10. The displacement theory; its fundamen- 
tal assumption. § 11. Magnitude of the inflow of immigrants. § 12. 
Earlier and recent effects of immigration upon wages. § 13. Laissez- 
faire policy of immigration. § 14. Social-protective policj" of immigra- 
tion. § 15. Post-war restriction of immigration. § 16. Population and 
militarism. § 17. Problem of maximum military power. 

§ 1. Nature of the population problem. No one of the 
problems of labor thus far discussed is of so great im- 
portance in its ultimate bearings upon popular welfare as 
is the "problem of population." By this is meant the 
problem of determining and maintaining the best rela- 
tion betM^een the population and the area and resources 
of the land. What is to be deemed "best" in this case 
depends, of course, on the various human sympathies 
and points of view of those pronouncing judgment. 
Very generally, until the nineteenth century, the only view 
that found expression was that of a small ruling class which 
favored all increase in population as magnifying the political 
power of the rulers and as increasing the wealth of the landed 
aristocracy. This view still is unconsciously taken by the 
members of a small but influential class, and is echoed with- 
out independent thought by many other persons. But more 
and more, in this and other labor problems, another more 

417 



Ch. 25] 



POPULATION AND IMMIGRATION 



419 




democratic standard of judgment has come to be taken, that 
of the abiding welfare of the masses of the people. This is 
the point of view that must be taken by the political econo- 
mist in a free republic. 

The problem of population presents two main aspects: one 
as to composition, and the other as to numbers of the people. 

Changes in either of these respects 
concern the welfare of the masses. 
Changes in the kinds of people, or 
in their relative numbers, may 
greatly affect the welfare of the 
people, in some cases touching 
special large classes, and in others 
affecting the whole mass of the 
people. 

§ 2. Complexity of race prob- 
lems. The questions of race com- 
position that we shall here consider 
are those of the negro and of the 
immigrant.^ Both of these ques- 
tions are complex and go beyond 
the limits of mere economic considerations, touching the most 
vital political and social interests of the nation. Indeed, they 
involve the very soul and existence of peoples, for who can 
doubt that ultimately racial survival and success are mainly 
to be determined by physical and spiritual capacity? 

The negro in America is the gravest of our population prob- 
lems. In large portions of our land it overshadows everj' 
other public question. Yet the negro is here because men of 
the seventeenth century ignored the complexity of the labor 
problem and thought only of its economic aspect. The land- 

1 Even more important than these is the relative decrease of the suc- 
cessful strains of the population, briefly treated in Vol. I, ch. 33. This 
is the problem of eugenics, the choice and biologic breeding of capable 
men to be citizens of the nation, and, broadly understood, it includes 
both the negro and the immigrant problems. 



WORLD TOTAL 
1.792.000,000 PERSONS 

Fig. 2, Chapter 25.— Pop- 
ulation of the World. — Com- 
parison of Nations. 



420 WAGES AND LABOR [Pt. IV 

owners wished cheaper labor, and, reckless of other conse- 
quences, they imported slaves from Africa to get it. They 
gained for themselves and a few generations of their de- 
scendants a measure of comparative ease, but at a frightful 
cost to our national life — a cost of which the Civil War now 
seems to have been merely a first instalment on account, rather 
than a final payment. 

§ 3. Economic aspects of the negro problem. The negro 
as a wage-earner is found very little outside of the least 
skilled branches of a limited range of occupations. Of these 
the principal ones, as is a matter of common knowledge, are 
farm work, domestic service (including janitor service in 
stores and factories and work in hotels), and crude manual 
outdoor labor. Repeated attempts to operate factories with 
a labor force of negroes have proved unsuccessful. In some 
of the better-paying occupations in which large numbers of 
negroes were found in the North soon after the Civil War, 
such as barbering, waiting on table in the best hotels, and 
skilled manual work, they have been largely displaced by 
\ European immigrants. Negroes are a disturbing and unwel- 
come influence in labor organizations, and even when nom- 
inally eligible to membership are in fact rarely accepted. 
They very frequently are employed as strike-breakers, and 
this fosters race antagonism both immediately and perma- 
nently. 

The negro problem is, from our present outlook, insoluble. 
The most laudable of present efforts, that for industrial train- 
ing, represented by Hampton and Tuskegee Institutes and 
the work of Booker T. Washington, leaves the dire fact of 
two races side by side and yet unassimilated socially, politi- 
cally, and, in large measure, economically — a situation that 
involves the undemocratic principle of caste distinctions. 
Segregation in a separate state, or separate states, a thorough- 
going plan that has been proposed, is practically impossible. 
The disappearance of all color and race prejudice in respect 
to marriage, accompanied by miscegenation, or the complete 



Ch. 25] POPULATION AND IJ^IMIGRATION 421 

merging of the negro with the white population, as has oc- 
curred in some countries, is the ideal of some radical negro 
leaders, but is so repellent to the thought of white Americans 
that it cannot be looked upon as a solution. Yet the fact of 
the continual admixture of white and negro strains, occurring 
first mainly in the lower social strata of the two groups and 
through illegitimate relations, cannot be ignored. As a con- 
sequence of this there is occurring a slow infiltration of the 
negro strain into the white population, by the process known 
among the negroes as ''going over to white," which will 
go far toward race admixture in a thousand years, a period 
brief in the history of nations. 

Finally, there is the conceivable, but improbable, event of 
the decrease and extinction of the negroes in America. 
Their absolute number still continues to increase, but their 
relative number has declined since 1800.- It seems probable 
that if European immigration were to be stopped a very large 
migration of negroes from the South to the North and the 
West would occur to take places hitherto filled by unskilled 
immigrant workers. In the year 1915, following the check to 
immigratian as a result of the European war, a very marked 
movement of this kind set in, and continued until about 1920. 
If this occurred on a large scale it might result in actually 
reducing the negro population in some portions of the South ; 
and as the "rate of natural increase" of the negroes in the 
North is a negative quantity, it might cause the total negro 
population of the country to begin absolutely decreasing. 
The census of 1920 showed the remarkable fact that the decen- 
nial increase of the negro population had been but 6 per cent, 
as compared with more than 11 per cent in the preceding dec- 
ade (the lowest up to that time). 
-^ — § 4. Favorable economic aspects of earlier immigration. 
By the "immigration problem" is meant primarily and mainly 

2 See Vol. I, p. 430, figure 58, showing the fall in the decennial rate 
of increase of negroes compared witU whites; and see comment in ac- 
companying note. 



422 WAGES AND LABOR [Pt. IV 

the complex of evils, economic, political, and social, caused 
by the present inflow of immigrants. Regarding this we are 
not confined to futile expressions of regret, as in the last 
case. We can by legislation limit or stop their coming, if we 
will. The first question to answer is, whether their coming 
really is an evil or, on the whole, a blessing to the country. 
The historic American attitude toward immigration has 
been highly favorable to it. The early settlers on these coasts 
were led by various motives, some political, some religious, but 
far the largest part economic — the motive of bettering their 
worldly condition. Land was plentiful, and all men of any 
capacity could easily become landowners. An inflow of la- 
borers was favorable to the interests of all the influential 
elements of the population, especially to landowners and ac- 
tive business men. Increase of numbers, favoring division 
of labor and the economies of production in manufacturing, 
and reducing the dangers from Indians and from foreign 
enemies, seemed an unmixed blessing. Many of the new- 
comers soon became landowners and employers, and in turn 
favored a continuance of the movement. Thus was hastened 
the peopling of the wilderness. The interest of these classes 
harmonized to a certain point with the public interest; but 
likewise it was in some respects in conflict with the abiding 
welfare of the whole nation. It led to the fateful introduc- 
tion of slavery from Africa, and it encouraged much inferior 
immigration from Europe, the heritage of which survives in 
defective and vicious strains of humanity, some of them notori- 
ous, such as those designated as the Jukes, the Kallikak family, 
and the tribe of Ishmael. 
^ — -| 5. Employers' gains from immigration. The immigra- 
tion from Europe has furnished an ever-changing group of 
"workers, moderating the rate of wages that employers other- 
wise would have had to pay. The continual influx of cheap 
labor aided in imparting values to all industrial opportuni- 
ties. A large part of these gains have been in trade, in manu- 
factures, and in real estate as the cities have taken and re- 



Ch. 25] rOPULATIOX AND IIVEVIIGRATION 423 

tained an ever-growing share of the immigrants. Successive 
waves of immigration, composed of different races, have ever 
been ready to fill the ranks of the unskilled workers at wages 
somewhat lower than the current American rate. 

The lower enterprisers' costs that resulted from immigra- 
tion surely did not accrue to the advantage of the employers 
alone. Bearing in mind the fact that the employing-enter- 
priser is a middleman,^ we may see that the lower costs must, 
in most cases, be passed on to the consumers in the form of 
lower prices of products. And often the consumer, as the 
emploj^er of domestic service at lower rates than otherwise 
would be possible, gets this advantage directly. This in- 
creases the number of those whose self-interest, at least when 
narrowly judged, leads them to favor the policy of unre- 
stricted immigration. This sentiment in favor of immigration 
is still potent, though perhaps less general than it once was. 
The continuous inflow of immigrants has in many industries 
come to be looked upon as an indispensable part of the labor 
supply. Conditions of trade, methods of manufacturing, 
prices, profits, and the capital value of the enterprises have 
become adjusted to the fact. Hence results one of those il- 
lusions cherished by men whenever they identify their own 
profits with the public welfare. Without immigration, it is 
said, "the supply of labor would not be equal to the de- 
mand." It would not at the wages prevailing. But supply 
and demand have reference to a certain price. At a higher 
wage the amount of labor offered and the amount demanded 
would come to an equality. This would temporarily curtail 
profits, and other prices would, after readjustment, be in a 
different ratio to wages. 

§ 6. Pressure of immigration upon native wage workers. 
There must always have been cases where the labor incomes 
of workers were somewhat depressed by the incoming of im- 
migrants. Indeed, that must to some extent alwaj^s be so 
when the natives continue to work alongside of the immigrant 

3 See ch. 21, § 16, and references in note. 



424 



WAGES AND LABOK 



[Pt. IV 



at just the same job. But before the Civil War living con- 
ditions were simple, wages comparatively high and (more im- 
portant) pretty steadily rising, and the wage-earning class 
not yet a large share of the population. Moreover, this con- 
flict of interest was minimized and often quite avoided by the 
native changing to another occupation. In the old days there 
was always the outlet of free land on the frontier, now closed. 
Always there has been a better opportunity for natives to 
move into higher positions of foremanship or as employers 
of immigrant labor. 

■^ As the wage-earners have become relatively a more numer- 
ous, and permanent class in the United States, many of them 
have felt more keenly the pressure of competition from immi- 
grant labor. Moreover, the immigration since 1890 has been 
increasingly from southern and southeastern Europe, from 
countries with much lower standards of living, and has been 
of enormous proportions. Here are some significant figures 
as to immigration since 1820 : 









Immigration, 




Immigration 


Increase of 


per cent of 


Decade 


in the period 


population 


population 








increase 


1821-30 


124,000 


3,300,000 


3.8 


1831-40 


528,000 


4,200,000 


12.3 


1841-50 


1,604,000 


6,100,000 


26.3 


1851-60 


2,648,000 


8,200.000 


32.3 


18&'l-70 


2,369,000 


8,400,000 


28.2 


1871-80 


2,812,000 


10,400,000 


27.0 


1881-90 


5,246,000 


12,700,000 


41.3 


1891-1900 


3.687,000 


13,100,000 


28.1 


1901-1910 


8.795.000 


16,000.000 


55.0 


1911-1920 


5,736,000 


14,200,000 


40.4 



Total, 100 yrs. 33,536,000 



96,800,000 



34.6 



In interpretating these figures it should be observed, how- 
ever, that in the last two decades many immigrants from 
southern and eastern Europe have been returning to their 
native lands. The net addition to population due to im- 
migration in this period, therefore, has been considerably 
less than the figures in the table indicate. Before this century 
the return flow of migration w^as very small. 



Ch. 25] 



POPULATION AND IjVIMIGRATION 



425 



§ 7. Abnormal labor conditions resulting from immigra- 
tion. The labor supply coming from countries of denser 
population and with low standards of living creates, in some 
occupations, an abnormally low level of wages and prieea. 
Children cannot be born in American homes and raised on 
the American standard of living cheaply enough to maintain 
at such low wages a continuous supply of laborers. Many 
industries and branches of industry in America are thus para- 
sitical. A condition essentially pathological has come to be 



1300 



Thou& 
1300 




'40 ^5 '50 "55 '60 '65 '70 '75 "80 '85 '90 "95 '00 '05 '10 '15 "20 

Fig. 3, Chapter 25. — A century of immigration. 

looked upon as normal. The commercial ideal imposes itself 
upon the minds of men in other circles. 

Statistics show that the prevailing wages for unskilled man- 
ual workers in America rose much less in the half century 
after the Civil War than did other wages.'* Wages in the great 
lower strata of the unskilled and slightly skilled workers are 
much lower in America relative to those of more skilled and 
professional workers than they are in Europe. It can hardly 
be doubted that the most important, though not the sole, cause 
of this situation has been the unceasing inflow of immigrants 



* See below, sec. 12. 



426 



WAGES AND LABOR 



[Pt. IV 



going into these low-paid occupations. The "general eco- 
nomic situation" in America, but for immigration, would com- 
pel higher wages to be paid to the masses of the workers. If 
"immigration were suddenly stopped in a period of normal 
or of increasing business, wages in these occupations would 
at once rise, and that without the aid of organization, of 
strikes, or of arbitration. This would affect most those oc- 
cupations which now present the most serious social prob- 
lems, in mines, factories, and city sweatshops. In some small 
measure the war in the Balkan States, by recalling many men 



1100 

laao 
too. 
600 



zoo. 
100. 



Immiorrtion 

1907- 1921 





A m m Wa W. 

E)fCES5,,0r Immicrrtion'; 



OVER EMIGRflfjC 

i 



m 




I in ivi 1 1/ n n i i u i> , 

'AA VA'A m- 

MIGRATION y/. 

i 



11 




07-oa 0S03 03-10 10-U 11J2 t8<13 1314 MiS »■ l6 |6I7 J7ia 18-13 ISaO 20£J 

Fig. 4, Chapter 25. Immigration and alien emigration, 1907-1921 



for service, had this influence in 1912; and the great war 
beginning in 1914, by stopping a large part of the usual im- 
migration, gave a striking demonstration of this principle. 
In employing circles the rise of wages was sometimes referred 
to with an air of grievance as due to the ' ' monopoly of labor, ' ' 
as if the economic situation here, enabling the wage-earners 
(millions of them immigrants) to get a higher competitive 
wage when immigration temporarily was diminished, consti- 
tuted a monopoly. 



Ch. 25] POPULATION AND IMMIGRATION 427 

§ 8. Popular theory of immigrant competition. The de- 
pressing effect of the ever-present and ever-renewing supply 
of immigrant labor upon wages appears most clearly at the 
time of wage contests, and often seems to be the most impor- 
tant aspect of the question. Laws against importing labor 
under contract, passed to prevent this particular evil, puts no 
check to the great stream of those guided by friends to a 
"job." Organized jabor thinks most of these immediate 
effects. Commonly labor 's protest is expressed in terms of the 
untenable "lump-of -labor" theory of wages. "Every foreign 
workman who comes to America" is believed to take "the place 
of some American workman." The error in this too rigid con- 
ception of the influence exerted upon wages by new supplies of 
labor is evident in the light of the principles of wages. Yet it "' 
may be true that, both immediately and ultimately, the for- 
eign workman depresses the incomes of those already here 
with whom he directly competes. On the other hand, those 
in occupations into which few immigrants enter may, as con- 
sumers of cheaper products, be immediately the gainers in 
real wages, by the very change that depresses the wages in the 
lower strata.^ The manufacturing-employers advocate "pro- 
tection" that enhances the price of their products, while 
usually favoring "free trade" in immigration to cheapen 
their costs. What more natural than that laborers should 
favor a policy of protection to labor, to keep foreigners from 
coming here to be their competitors? 

§ 9. Divergent views of effects on population. The fore- 
going views of the effects of immigration upon wages, both 
of those favoring and those opposing it, are short-time views, 
relating to immediate rather than ultimate effects. If the 
immediate causes are continuously repeated throughout the 
lives of successive generations, the results are for those mor- 
tal men as ultimate as anything that concerns them. In this 
case it would make no difference to the millions of workers, 
whose wages are depressed, if it could be shown that wages 

5 See Vol. I, p. 221, on non-competing classes. 



42S WAGES AND LABOR [Pt. IV 

fifty or a hundred years from now would be no lower as a re- 
sult of continued immigration than they otherwise would be; 
or to the employer that wages would then be no higher. But 
to the social philosopher and to the statesman, interested in 
the abiding general welfare, the ultimate economic effects are 
of the greatest importance. 

The question is: What will be the far-reaching, long-time 
effects of immigration upon the general economic situation, 
as that determines the welfare of the mass of the people ? We 
confine ourselves here to the economic effects, leaving aside 
as far as possible the racial, moral, religious, political, and 
general social aspects of the subject. 

We are met at the outset by two divergent opinions as to 
the permanent results of immigration upon the growth of 
. population. The one opinion is that all immigrants coming 
to our shores are net additions, hastening by so much the 
growth in density of population ; the other is that immi- 
gration has the effect of checking the natural increase of 
the native stock so much that it does not materially change 
the total population, or actuallj^ causes it to be less than 
it would have been had no immigration occurred. 

§ 10. The displacement theory; its fundamental assump- 
tion. The latter view, known as the displacement theory, was 
first advanced by a distinguished economist, Francis A. 
Walker, but his first statement of it referred only to the period 
between 1830 and 1860. The main argument in support of 
this opinion was that in the three decades from 1830 to 1860, 
during which a large immigration occurred, the decennial 
rates of increase of the population were almost the same as 
in the three decades from 1800 to 1830.'' The concbision 
drawn from these figures was that the immigrants were the 
cause (by the economic pressure they created) of the decline 
of the birth-rate occurring in the native stock. The validity 

6 See Vol. I, p. 429, for figures of population and of decennial rates 
of increase; also § 6, above. 



Ch. 25] POPULATION AND UVOIIGRATION 429 

of this conclusion is dependent on the assumption that no 
other forces were at work to produce this result. IMust we be- 
lieve that, but for immigration, the native birth-rate would not 
have declined at all ? This is incredible. The birth-rate of the 
native stock had already begun to decline before 1820, as is 
shown by many family records, and by the fall of the decen- 
nial rate of increase from 35 and 36 in the decades ending 
1800 and 1810, to 33.1 and 33.5 in the next two decades. This 
occurred despite the enormous western settlement then under 
way on the Louisiana Purchase. The decline of the birth- 
rate began at that time to appear as a world-mde phenome- 
non, accompanying improved transportation (roads, steam- 
boats, steam railways), the rapid growth of cities, and the 
general industrial revolution. The general birth-rate has de- 
clined of recent j^ears in Australia and New Zealand, where 
there has been little immigration, more rapidly than it has 
in the United States.^ 

§ 11. Magnitude of the inflow of immigrants. The 
displacement theory still has upholders,* but in view of 
the facts it seems necessary to modify it greatly. To the 
extent that the coming of immigrants caused a net addi- 
tion to the population, it doubtless hastened the growth 
of cities and the development of industrialism, and 
thus helped to reduce the birth-rate in some classes. But 
this view admits the effect upon population which the dis- 
placement theory denies. Probably in a good many cases the 
more rapid business advancement of the natives, because of 
the coming of the immigrants, led to the decline of birth-rate 

~ The effect of the growth of cities is discussed in the "American 
Journal of Sociology," Vol. 18, p. 342, in an article on ''Walker's 
Theory of Immigration," by E. A. Goldenweiser. 

8 One of the best recent statements of it is that of H. P. Fairchild, 
in "Immigration," pp. 215-225, citing various opinions, and accepting 
the view of Walker. But he says (p. 216) : "It must be admitted 
that this is not a proposition which can be demonstrated in an abso- 
lutely mathematical way, which will leave no further ground for 
argument." 



430 WAGES AND LABOR [Pt. IV 

that is a consequence of economic success.^ But a large part 
of this change would have inevitably occurred even if there 
had been no immigration after 1820. Between 1820 and 1910 
the population increased 82,400,000, and the total number 
of immigrants was 27,800,000, or 33.7 per cent of the total 
increase. The birth-rate among immigrants in cities always 
has been very much higher than that of native Americans, in 
the same cities. This fact alone might well be taken as 
sufficient to offset whatever depressing effects the coming of 
the immigrants may have had upon the native birth-rate, leav- 
ing the immigration nearly a net addition to population. It 
does not seem possible to believe that, if there had been no 
immigration, our native population, rapidly advancing in 
average wealth, wages, and general education, would have 
continued with an unchecked birth-rate, and would have filled 
all the places taken by immigrants. And no believer in the 
displacement theory has ever ventured to claim, as the argu- 
ment requires, that if immigration were now stopped the 
birth-rate would again return to the old standard of 1820, or 
would cease to decrease somewhat. Especially of late, since 
the rate of increase of the native population has become much 
less, is the effect of continuing immigration apparent. In 
the decade of 1900-1910 the total population increased 16,- 
000,000, while nearly 9,000,000 immigrants arrived. Of the 
remaining increase, 3,000,000 consisted of children born of 
foreign parents. That leaves, at the most, 4,000,000 in- 
crease attributable to the native stock, white and negro com- 
bined. 

§ 12. Earlier and recent effects of immigration upon 
wages. Let us now correlate the principle of decreasius: re- 
turns and the facts as to the exploitation of our natural re- 
sources " with the growth of our population, on the assump- 
tion that immigration has made more or less of a net contribu- 
tion to our numbers. While the vast frontier was open to set- 

8 See Vol. I, p. 420. 

10 See Vol. L chs. 34 and 35. 



Ch. 25] POPULATION AND liEVIIGRATION 431 

tlement the growth of population could not fail to be looked 
upon as a blessing, even though somewhat mixed with political 
evils, immorality, and pauperism. Beginning in colonial times, 
the policy of the "open door" to immigrants came thus to be 
deemed the traditional patriotic American policy. Yet there 
is grave reason to believe that the rate of growth in the nine- 
teenth century was wastefully rapid and that a slower and 
sounder growth might have been better.^^ However, this 
rapid growth was largely extensive, spreading over wider 
areas, and was consistent with a pretty steady rise of real 
wages in America until about 1895,^^ the level continuing 
higher than that of Europe despite the contemporaneous rise 
of wages there. Much of this general rise is undoubtedly at- 
tributable to the adoption of better tools, machinery, and in- 
dustrial processes, the more so as inventions and new methods 
have rapidly become free goods.^^ The beneficial improve- 
ments long cooperated with the rapid exploitation of rich re- 
sources to raise real wages, and then undoubtedly continued 
to offset for a time the unfavorable effects as the richer re- 
sources began to show signs of exhaustion. About the begin- 
ning of this century, however, the net trend upward seems 
to have been checked, and the "rising cost of living" (real 
cost) became a serious actuality for larger sections of the popu- 
lation.^* 

Yet as long as wages are enough higher in America to pay 
the passage of the low-paid workers of the industrially back- 
ward nations, they will continue to come. The ease and 
cheapness of migration in these days of steamships, the en- 
couragement of immigration by the agencies and advertise- 
ments of the steamship lines, and the increasing readiness 

11 E. g., see above ch. 16, § 11, on the prodigal land policy. 

12 See Vol. I, p. 436 ff. 

13 See Vol. I, ch. 36, on machinery and wages. 

1* For analysis of the available statistics bearing on the subject, with 
conclusions that real wages are no longer rising, see H. P. Fairchild in 
"American Economic Review" (March, 1916), "The Standard of Liv- 
ing — Up or Down?" 



432 WAGES AND LABOR [Pt. IV 

of the peasantry to migrate have become well-known through 
recent discussions. Unless immigration is limited, it must 
continue to depress the wages of American workingmen, 
through both its immediate and its ultimate effects, 

§ 13. Laissez-faire policy of immigration. There are 
those who take a fatalistic view of the subject, and this 
results in a laissez-faire policy. They declare that the 
problem will solve itself as the level of American wages 
comes to be nearly the same as that of the countries 
of Europe from which our imagination is coming. True 
enough, if this can be called a "solution." There are 
many who cherish the commercial ideal according to which 
^ cheap labor is absolutely desirable and needful to produce 
cheaper products. This ideal has spread to wider circles. 
Here, for example, are the words of a man who combines wide 
knowledge of the facts of immigration with keen sympathy 
for the working-classes : ^^ " Tj^g p^g^ industrial development 
of America points unerringly to Europe as the source whence 
our unskilled labor supply is to be drawn. . . . America is 
in the race for the markets of the world ; its call for workers 
will not cease. ' ' Yet a little further on he must say : ' ' All 
wage-earners in America agree that it is not as easy to make 
a living to-day as it was twenty years ago, and the dollar 
does not go so far now as it did then. The conflict for sub- 
sistence on the part of the wage-earner is growing more stern 
as we increase in numbers and industrial life becomes more 
complicated, and the fact must be faced that the vast army 
of workers must live more economically if peace and well- 
being are to prevail." 

§ 14. Social-protective policy of immigration. A differ- 
ent kind of solution is offered by those who favor the strict 
limitation, if not the complete prohibition, of immigration. 
The foregoing study indicates that the time has come, if it is 
not far past, when the traditional policy of fostering immi- 

15 Peter Roberts in "The New Immigration," 1912, preface, p. viii, 
and p. 47. 



J 



Ch. 25] POPULATIOX AND lALNIIGRATION 433 

gration is opposed to the welfare of the masses of the peo- 
ple. This belief can be based solely on grounds of numbers, 
the relation of population to resources, quite apart from a 
preference for particular races or the familiar arguments re- 
garding social and political evils and lack of assimilation, 
however valid they may be. The limitation of immigration 
would at once improve working-class conditions where they 
are worst in America,^'' and would check and probably 
reverse the tendency to diminishing returns already manifest 
in many directions. This opinion does not necessitate an ab- 
solute prohibition of immigration ; it is consistent with the 
continuance of immigration of a strictly selected character, 
and in numbers so small that all European immigrants now 
here could be rapidly and completely assimilated, econom- 
ically and racially. With a slow national increase of popula- 
tion and with the continued progress of science and the arts, 
it should be possible for real wages to continue indefinitely 
rising in America. The selection of immigrants to be admit- 
ted should be a part of a national policy of eugenics,^^ which 
aims to improve the racial quality of the nation by checking 
the multiplication of the strains defective in respect to men- 
tality, nervous organization, and physical health, and by en- 
couraging the more capable elements of the population to con- 
tribute in due proportion to the maintenance of a healthy, 
moral, and efficient population. In such a view, a eugenic 
opportunity is presented in the selection and admission of 
immigrants who are distinctly above (not merel}- equal to) 
the average of our general population. 

§ 15. Post-war restriction of immigration. Many events 
of the war period, and particularly of the years 1917 and 1918, 
affected greatly American opinion on the immigration ques- 
tion. That large part of our alien population which was 
from the allied countries or from disaffected races (such 
as the Poles and the Czechs) and from neutral countries 

16 See above, § 7 ; also ch. 22, § 9. 

17 See above, § 2, note; also Vol. I, p. 422. 



434 WAGES AND LABOR [Pt. IV 

assumed their full share of the military and other patriotic 
duties of the time; as did many natives of the Central Em- 
pires. But in many eases were revealed our lack of na- 
tional unity and consciousness as a result of recent immigra- 
tion, the failure of the ''melting-pot" to melt, and wide- 
spread sedition and disloyalty among the aliens who had 
been welcomed to our shores. In the period of agitated 
feelings, of unsettled labor conditions, and of a threatening 
Bolshevism, the desirability of a "wide-open" policy of 
immigration came to be doubted in the very circles where 
immigration had been most strongly favored before. Large 
employers and the well-to-do classes recognized the threat 
to our institutions in the presence here of so many alien 
elements, un-American in thought and feeling, and em- 
bittered against all established political and economic institu- 
tions as a result of their experiences in their native lands. 
The first legislative fruit of this public opinion was the en- 
actment by Congress of the temporary restriction law, which 
M^ent into effect June 3, 1921. Of several restrictive laws 
that have passed both houses of Congress since Cleveland's 
administration, this was the first that was signed by the Presi- 
dent. It limits (to the end of the fiscal year 1922) the immi- 
gration from each foreign country to 3 per cent of the number 
in the United States by the census of 1910. Immigration had 
already begun to rise to the pre-war rate. In the fiscal 
year ending June 30, 1921, immigrants to the number of 
805,228 were admitted, while 247,718 departed, making a net 
addition of 557,510. The total number that can be admitted 
under this law, if each country sent its full quota, would be 
354.000. This law, if supplemented by other legislation be- 
fore 1922, will have inaugurated a new era of immigration 
policy in the United States. 

§ 16. Population and militarism. In view of the re- 
crudescence of the spirit of armed national aggression 
apparent in the outbreak of the Great War in 1914, 
the military aspect of the population question deserves 



Cn. 25] 



POPULATION AND UVEVIIGRATIOX 



435 



serious consideration. The growth of savage and barbarian 
tribes in numbers, so that their customary standards of living 
were threatened, frequently has led to the invasion and con- 
quest of their neighbors.^'' To-day nations on a higher 
plane of living are probably repeating history. The nation 
with an expanding population is tempted to seek an outlet for 
its numbers and for its products by entering upon a policy 

TOTAL 1035 



ALL OTHER 



446 



RUSSIA 



ITALY 



m 



SCANDINAVIA 
GERMANY 



UN (TED KINGDOM 

AV.191(H4 



\3S6 



W^ mm 

H89H mSSM 



1921-E2 



Fig. 5, Chapter 25. Immigration restriction law of 1921; restric- 
tive effects upon various nationalities, shown graphically. 

of commercial expansion, which in turn has to be supported 
by stronger military and naval establishments. It is led by 
primitive impulses that to itself seem to be a moral justifica- 
tion, to possess the territory of its neighbors. Such a nation 
points to its increasing population and declares that it must 
have its "place in the sun"; it must find lands and food for 
its swarming numbers. Other nations with lower birth-rates 
and higher standards of living, which they seek to preserve 



18 See Vol. I, p. 412, on war and the pressure of population. 



436 WAGES AND LABOR [Pt. IV 

by various measures excluding immigTation, appear to be 
greedy, malevolent, and insulting. These are not the con- 
ditions for rational thinking. The immediate occasion 
of war may be some matter of internal politics, such as 
growing discontent and democratic sentiment among the 
people, while the deeper cause is the pressure of population in 
a limited territory. Nations with slowly growing populations, 
and still possessed of ample territories to maintain their ac- 
customed standards of life, naturally favor the status quo, and 
are pacifist or non-militarist. If they arm, it is for their own 
safety. In this view, militarism is seen to consist, not in hav- 
ing drilled soldiers and stores of munitions, but in the na- 
tional state of mind that would use these for aggression, not 
merely for defense. When, therefore, a powerful nation has 
reached a certain stage in the relation of its population to 
resources, limitation of population more truly than limitation 
of armaments is the real pacifism ; and increase of population, 
not increased military training or a larger navy, is the real 
militarism. 

§ 17. Problem of maximum military power. It is a grave 
question, however, how far a nation with a relatively 
sparse population, high wages, and great wealth can safely 
limit population in the presence of a capable, ambitious, 
and efficient rival that covets such opportunities. On the 
one hand, a population may be so sparse that it has not sol- 
diers enough to defend its territory against a numerous 
enemy; on the ,other hand, it may be so dense, and conse- 
quently average incomes be so low, that it cannot properly 
train, arm, and support its population of military age. The 
recent developments in the art of warfare call for great use 
of the mechanical industries, for great power to endure taxa- 
tion, and for great financial resources, conditions found only 
■where the average of national income is high. The point of 
maximum military power must be far short of the maximum 
possible population. It would seem that a nation of 100,000,- 
000 inhabitants favorably situated to resist aggression, well 



[Pt. IV POPULATION AND IMMIGRATION 437 

supplied with the natural materials for munitions, and well 
equipped to produce them, might safely limit its numbers so 
as to insure a high level of popular income. This safety 
would be greatly increased by permanent alliance with other 
peoples likewise limiting their numbers and, therefore, in- 
terested in maintaining the peace of the world. In this way 
it would be possible for them all to maintain a standard of 
popular well-being even higher than is fully consistent with 
the maximum military power, even in the presence of pro- 
lific and aggressive rival nations. 

References. 

Adams and Sumner, ch. III. 

Com.mons and Andrews, ch. II, sec. 4. 

Commons, J. R., Races and immigrants in America. Revised. 1920. 

Davis, P., Immigration and Americanization. Selected Readings. 

Best. Ginn. 1920. 
Fairchild, H. P., Immigration. 1913. 

The standard of living — up or down? A. E. Rev., 6: 9-2.5. 

1916. 
Fetter, F. A., Population or prosperity. A. E. Rev., 3 (no. 1, 

supp. ): 5-19. 1913. (Presidential address before the American 

Economic Association, 1912; partly incorporated with chap. 25 

in the text.) 
Foerster, P. F.. The Italian emigration of our times. Pp. 558. 

Cambridge. Harvard University Press. 1919. 
Goldenweiser, E. A., Walker's theory of immigration. Am. J. Soc, 

18: 342-351. 1912-1913. 
Grant, M.. The passing of the great race. Pp. 245. New York. Scrib- 

ners. 1916. 
Hamilton, W. E., Readings in current economic history. P. 384- 

386, 392-395. Univ. of Chic. Press. 1914. 
Jenks, J. W., and Lauck, W. ./., The immigration problem. Pp. 605. 

4th ed. N. Y. Funk. 1917. 
Materials for the study of elementary economics. 146-156. Chic. 

Univ. Press. 1913. 
Millis, H. A., Some economic aspects of Japanese immigration. 

A. E. Rev., 5: 787-804. 1915. 
Roberts, Peter, The new immigration. N. Y. 3Iacmillan. 1912. 
Ross, E. A., The old world in the new. N. \'. Century. 1914. 
Warne, F. J., The tide of immigration. N. Y. Appleton. 1916. 



PART V 
PUBLIC POLICY TOWARD PRIVATE INDUSTRY 



CHAPTER 26 



AGRICULTURAL AND RURAL POPULATION 

§ 1. Sources of food and organic materials. § 2. Agriculture and 
farms in the United States. § 3. Rural and agricultural. § 4. Lack 
of a social agricultural policy in America. § 5. Period of decaying 
agricultural prosperity. § 6. Sociological effects of agricultural de- 
cay. § 7. Fewer, relatively, occupied in agriculture; use of machin- 
ery. § 8. Transfer of work from farm to factory. § 9. The rural ex- 
odus. § 10. The farmer's income in monetary terms. § 11. Com- 
pensations of the farmer's life. § 12. Ownership and tenancy. 

§ 1. Sources of food and organic materials. The land 

area of the United States is about 1,900,000,000 acres, of 
which 879,000,000 acres were in farms in 1910, this being 46 
per cent of the total area. A very small part of the ret- 
mainder is used for residential and commercial pur- 
poses, the rest being barren mountains, deserts, swamps, and 
forests. Of the total in farms a little more than one 
half was improved, 478,000,000 acres altogether, a per 
capita average of 5.2 acres; and a little less than one 
half was unimproved, 400,000,000 acres altogether, a per 
capita average of 4.3 acres. The improved land pro- 
duced not merely food but many kinds of materials, such as 
cotton, wool, hides, and lumber, while much of the unim- 
proved land was either in farm wood-lots or in rough range 
pasture. Of course, the kinds and amounts of produce per 
acre vary with the climate, particularly with sunshine and 
rainfall; possibly the proportion of the area of the United 
States that is true desert and infertile mountain-land is 
greater than that of any other equal area in the temperate 
zones. The actual productive capacity per acre of the lands 

441 



442 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

of America cannot be expressed in a very helpful way as a 
peneral average per acre, but each area must be carefully 
studied in respect to its climate, rainfall, and possibility of 
irrigation and drainage. It is apparent that a very large 
number of economic problems must arise in connection with 
the land supply for food: such as problems of land-owner- 
ship, taxation, irrigation, drainage, forestry, and encour- 
agement or limitation of population. We are just beginning 
to awake to the needs in this direction. The farm-lands 
supply, besides food, a large part of the raw materials 



FOREST REGIONS OF THE UNITED STATES 




FOREST SERVICE 



Fig. 1, Chapter 27. Acreage; of Corn. 
for many other goods, all such organic materials as cotton, 
flax, wool, hides, feathers, lumber, and firewood. The 
farm wood-lots compose about 200,000,000 acres, and the 
large forests, public and private, about 350,000,000 acres, a 
total of about one fourth the area of the country in forests, 
containing about one half of the lumber that the country once 
possessed. The economic problem of a sound forestry i)olicy 
is one of the most important we have to solve. 

The rivers, lakes, and ocean waters near our coasts are 



Cir. 26] AGRICULTURAL AND RURAL POPULATION 443 

other great sources of food, but no statistics are available to 
show adequately their yield. Few of them are in private 
possession, and they do not appear at all in a total of "capi- 
tals, ' ' yet they are more important to the nation than a large 
part of the land area. They are onh- beginning to be de- 
veloped artificially by the propagation of oysters, clams, and 
fish. The development of a proper fishery policy is an eco- 
nomic problem closely connected with that of agriculture. 

§ 2. Agriculture and farms in the United States. There 
were nearly 12,400,000 persons in the United States gain- 
fully occupied in agriculture in 1910, this being 32.5 per cent 
of all in occupations. These, together with other family 
members not reported as engaged in gainful occupations, 
constitute the agricultural population, and comprise more 
than one third of the total population of the country. "Agri- 
culture" is here used in a broad sense, including floriculture, 
animal husbandry (poultry, bee culture, stock-raising), 
forestry and lumbering, and is even extended to include 
regular fishing and oystering. 

With the exception of areas devoted to forestry on a large 
scale and to fishing, the industry of agriculture is pursued on 
the 6,400,000 farms, covering 46 per cent of the total land 
area of the eomitry. Of the land in farms, a little more than 
half is classified as improved. The estimated value of farm 
property, including buildings, implements, machinery, and live 
stock, was, in 1910, about $41,000,000,000, somewhere near 
one fourth of the estimated wealth of the country at that 
date. 

§ 3. Rural and agricultural. The adjectives rural and 
agricultural are often used loosely as synonyms. But agricul- 
tural refers primarily to the occupation of cultivating the 
soil, and is properly contrasted with other occupations, as 
mechanical and professional ; whereas rural refers to place of 
residence outside of incorporated places of a specified mini- 
mum population (of late, 2500), and is properly contrasted 
with urban, applied to those living in larger population 



444 PUBLIC POLICY TOWARD PPvIVATE INDUSTPvY [Pt. V 

groupings. In 1910 the rural population comprised 53.7 
per cent of the total population, but had fallen to 48.1 per 
cent in 1920. It is true that the two groups of the agri- 
cultural and the rural populations are largely composed 
of the same persons, but partly they are not. Many farm- 
houses, together with part or all of the farm-lands, lie in- 
side urban boundaries, and, besides, some persons engaged 
in agriculture reside in urban places. On the other hand, 
any one acquainted in the least with a rural district (in 
the statistical sense) can at once think of many persons 
living there that are not engaged in agriculture; they 
may be merchants, warehousemen, railway employees, 
physicians, handicraftsmen, teachers, artists, retired business 
men, and others. The percentages given in this and in the 
preceding section indicate that about three fifths of the rural 
families are engaged in agriculture and two fifths are not. 

It is often important to make this distinction, though it is 
difficult to do ; for some of the much-discussed rural questions 
are of a broad social nature, are matters of rural sociology, 
relating pretty generally to the rural population ; while other 
questions of "rural economics" are more strictly matters of 
agricultural economics and relate to the farm as a unit of 
industry, or to agriculture as an occupation. 

§ 4. Lack of a social agricultural policy in America. It 
is a common remark that the farmer lives an independent life. 
This develops in him a self-reliant spirit. He readily gives 
and takes simple neighborly help in informal ways, but he 
does not readily turn to government for aid. "While 
every influential urban group, organized or unorganized, — 
manufacturers, merchants, wage-earners, — has sought and ob- 
tained special protective social legislation, the farmer, from 
choice or necessity, has usually had to work out his economic 
problems unaided. The exceptions are few and of small im- 
portance. For example, the prodigal land policy of the state 
and national governments encouraging the settlement of the 
frontiers was not a farmers' policy. It was originally in- 



Cir. 2G] AGRICULTURAL AND RURAL POPULATION 445 

spired by the larger political purpose of extending the bounds 
of the nation; later it was advocated and fostered by a land- 
speculating element, linked with bad politics, in the frontier 
states, and not by farmers as such. It in time greatly in- 
jured the farmers of the eastern states. The "Granger leg- 
islation" to regulate railroad rates was so called by the East 
in a spirit of derision because it began in the distinctively 
agricultural states of the Northwest; but it had neither the 
aim nor the result of obtaining especially for farmei's any 
rates that were not open to every one on the same terms. 
The tariff rates on American agricultural products, placed 
in the acts as a matter of form, have, with minute exceptions, 
been ineffective to favor farmers, as the shipments were nearly 
all outward and few inward, while heavy and effective rates 
were placed on most things that the farmers had to buy.^ 

In part, the explanation of the lack of legislation favoring 
farmers is to be found in their small part and influence, as 
a class, in political affairs, outside of minor executive offices 
in toAvnship and county governments. In the st^te legisla- 
tures farmers are few relative to their numbers in the com- 
munity, and still fewer in either House or Senate in Wash- 
ington. IMoreover, the farmers have rarely asked or re- 
ceived, as a class, any favoring legislation. Among the real 
exceptions to the otherwise fair record of the farming 
class in this respect is the tax on oleomargarine and 
the special favor accorded to farmers' associations in the 
Clayton Act. It might be cynically said that the farmer has 
not been "sharp" enough to get his share of the "good 
things" that the business classes were passing around in pro- 
tective legislation. But farmers have, as has every economic 
group, interests that may legitimately be the subject of 
social legislation; whereas they have limited their attention 
to their private affairs at home and have been prone to vote 
patiently and proudly the "straight ticket" to elect business 
men and lawyers to office. There are evidences, with increas- 

1 See ch. 16, § 5. 



446 PUBLIC POLICY TOWAED PRIVATE INDUSTRY [Pt. V 

ing organization among farmers, of an intention to seek 
political power and favors, which promises to present a new 
problem of monopoly and bodes ill for the other elements 
of the community. The road of true progress is not toward 
more monopoly for farmers, but toward less monopoly for 
large business and favored commercial interests. 

§ 5. Period of decaying agricultural prosperity. Despite 
the fact that frequently in economic legislation the farmer has 
been the victim, every compaign orator admits that there 
is no other occupational class that is of greater impor- 
tance to the nation than are the farmers, or more deserving of 
prosperity. Every other part of the industrial organization 
of a nation is interrelated with its agriculture. Great changes, 
in respect to growth of population, immigration, exhaustion 
of natural resources, mechanical inventions, scientific discov- 
ery, and many things more, have been occurring, which have 
altered, and in some communities destroyed, the very 
foundations of agricultural enterprise in America since the 
close of the Civil War in 1865, But the farmers have been 
left to struggle individually with their individual difficulties, 
though the outcome was of the gravest portent to the whole so- 
cial economy. Such was the case in the period of agricul- 
tural depression from 1873 to about 1896.^ Multitudes of 
ancestral homesteads were then left behind by the last farmer- 
descendant of the old line. No longer able to make a living 
on the soil, he took up an urban occupation. 

§ 6. Sociological effects of agricultural decay. Such 
changes hastened, no doubt, the decline in the birth-rate of the 
old American stock. The places of many of these long-settled 
families remained unfilled, as thousands of abandoned farm- 
houses testified. The places of others were taken by a ten- 
antry, white or black, lacking the thrift of ownership; the 
lands of others passed to new owners, of alien races. The 
populations of many rural neighborhoods thus became hetero- 

2 See Vol. I, p. 347. 



Cii. 26] AGRICULTURAL AND RURAL POPULATION 447 

geneous, with results calamitous to the social life. Once pros- 
perous schools declined, once thronging country churches were 
deserted, and much of the old neighborhood democracy dis- 
appeared. When, about the year 1900, prosperity began 
slowly to return to the American countrysides in the form of 
rising prices of farm produce, it was in large part too late to 
remedy the evil, except as it may be done by generations of 
effort under more favoring conditions. There are merely 
suggested here some of the complex sociological effects of past 
economic changes in American agriculture. It is certain that 
in the future, also, the economic changes in this field will be 
related closely to social and political changes of a fundamen- 
tal character. 

§ 7. Fewer, relatively, occupied in agriculture; use of 
machinery. Probably ever since the first census in 1790, the 
relative number of agriculturists in this country has been 
decreasing. Beginning in 1880, the numbers of those occu- 
pied in agriculture for gain have been reported at the census 
in a form that makes them fairlj' comparable.^ 

The explanation of this decrease in the proportion of the 
population that is engaged in agriculture is twofold. The first 
is the real increase in the productive output per person in 
agricultural industry. In larger part this is due to the in- 
creasing use of machinery in place of simple hand tools, and 
the substitution of horse-, hydraulic-, windmill-, steam-, and 
gasoline-power for human labor. This change has been made 

3 It must be observed, in studying these figures, that farmers' wives 
and children, working at home, are not reported as gainfully occupied. 
But a widow or a spinster oAviier, if herself acting as the enterpriser, is 
reported as "occupied" in agriculture. The increasing number of such 
cases in the past generation in part explains the growing number and 
percentage of females in agriculture. 

Number occupied in agriculture Per cent of all persons occupied 
Males Females Both seoccs Males Females Both sexes 

1880... 7,068,658 594,385 7,66.3,04.3 ' 47.9 22.5 44.1 

1890... 7,787,539 678,824 8,466,363 41.4 17.3 37.2 

1900.. . 9,272,315 977,336 10,249,651 39.0 18.4 35.3 

1910... 10,582,039 1,806,584 12,388,623 35.2 22.4 32.5 



448 



PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 



readily in the regions of level fields, but of late has been 
made possible to a greater extent in hilly country by rearrang- 
ing and combining the old irregular fields into regular, 
fairly level rectangular fields easily tillable, while turning the 
rougher lands and hillsides into wood-lots and pastures.* One 
man, thus, driving three or four horses or a tractor, can do the 
work formerly done by two or more men and do it just as 




Fig. 2, Chapter 26.— All farm crops. 
Note: This does not include value of live-stock products, the total 
of which is fully half as great. 

well. The farmers' incomes in different parts of the coun- 
try vary pretty nearly with the amount of horse-power used 
per man. Economies equally great are made in the work 
done in the barnyards and barns. In most parts of the coun- 
try only a beginning has been made in these ways, and in fu- 
ture the census will continue to reflect the progress in these 
directions. 

§ 8. Transfer of work from farm to factory. The other 

■4 See further, ch. 27, § 1 and § 2, on the size of farms as an eco- 
nomic factor. 



Ch. 26] AGRICULTURAL AND RURAL POPULATION 



449 



part of the explanation of the decrease in the proportion of 
the population that is engaged in agriculture is that many 
operations are, step b}- step, being transferred from the farm 
to the factory. "Agriculture," we have observed, is a great 
complex of industries, in which many different products are 
taken from the first simplest extractive stage, and then put 
through successive processes to make them more nearly 
fitted for their final uses. Not so long ago grain cut in the 



wr-.c 



• q- I ; — ! T— ^v_ 




.^\'.\I.rE OF PRODUCTS OF MANUFACTUKES: 19119 /'"^"^'^p^' 

T'r--~. i MASS. 











• IISO.OOO.OCO 

O $111,500,000 to J1SO.OOO,COO 

a 575,000,000 to »112,500,000 

O 537,500,000 to 575,000.000 

O I«S than $37,500,000 



Fig. 3, Chapter 26. — ilanufactines. 
Note: The scale of valuation is not the same as in Fig. 2. Observe 
how in the northeast manufactures and farming are combined. 

field was threshed, winnowed, shelled, made into flour, and 
baked on the farm, as it still is in many places. Logs were 
cut into boards, planed, and made into houses or furniture 
by the farmer. The old-time farmer made by hand a large 
number of his farm implements — rakes, ax-handles, pumps, 
carts, and even wagons. Until a generation ago all butter, 
cheese, and other dairy products were made on the farm. 
Now these things are being done in steadily increasing pro- 
portion by workers classified as in the manufacturing indus- 



450 



PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 



tries, and agriculture contains fewer separate industries and 
processes. Of course, there is economy of labor in nearly all 
of these changes, but the number occupied in agriculture is 
greatly reduced. Many farmers and more farmers' sons are 
moving from agriculture into occupations of manufacturing, 
trade, transportation, and the professions, and are becoming 
more narrow specialists. 

§ 9. The rural exodus. The percentage of persons in 
the rural population changes at about the same rate as does 




Fig. 4, Chapter 26. — ^Products of mines, 
of farm crops and manufactures. 



Compare with distribution 



that of persons occupied in agriculture. In 1890 it was 64, in 
1900 it was 60, in 191Q it was 54, and in 1920 it was 48 per 
cent. The percentage of the population in cities of 8000 or 
more has steadily increased. This phenomenon has been 
marked in all of the countries that have been developing 
along industrial lines. It has been variously described as the 
''rural exodus," the ''abandonment-of-the-farm movement," 
and the ' ' cityward drift. " It is only in part explained by the 
change from agriculture to other occupations; perhaps even 



Ch. 26] AGRICULTURAL AND RURAL POPULATION 451 

as much it is due to the decline and disappearance in 
many rural places of small manufacturing and mercantile 
businesses before the competition of large business in the cit- 
ies. In much of the long-settled area of the country every 
hillside stream once turned a little mill to saw timber, grind 
com, forge iron, or weave cloth. Most of these mills are now 
deserted. In countless villages the old blacksmith shop, once 
a center of business, is abandoned. Here and there a patri- 
archal smith still serves a dwindling group of customers, and 
speaks with mingled pride and pathos of his sons, now in the 
automobile business in the city. The movement away from 
the countryside has been but little counteracted as yet, but 
may be more in future, by the growing enjojnnent of rural 
life, by the back-to-the-land movement, by interurban rail- 
ways, hy improved roads, by telephones, and by automobiles. 

The great growth of education (in the sense of school- 
ing) and rise of educational standards has put the country 
child at a disadvantage as compared with the child in the 
city. For this reason, great numbers of farmers' families 
move to villages and cities, to enable the children to attend 
high school, even when the move involves a sacrifice. Better 
roads and the consolidated country school, with free trans- 
portation for the pupils, replacing the one-room, one-teacher 
schoolhouse, have done much to meet this need. Still, as com- 
petent observers have pointed out, the normal farming life 
of the country is an education in the manual arts and in 
other waj's, so that even with briefer school terms the coun- 
try child may be better educated for life than is the city 
child. 

The public was startled to learn that the army tests showed 
that country youth, on the average, were not as healthy as 
city youth. Here, again, the progress of the cities in sani- 
tation, medical inspection in schools, care of teeth and of 
the eyes of school children, gymnasia, organized and directed 
physical recreation, etc., has left the country homes and 
the country children at a relative disadvantage. The natural 



452 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

advantages of country life (sunshine, healthy exercise in the 
open, freedom from noise and strain) cannot always com- 
pensate for the poorer water supply, defective sanitation, 
and lack of medical and surgical care for the growing child. 
Here is a field for future reform. 

§ 10. The farmer's income in monetary terms. Census 
figures and some additional investigations led to the estimate 
of the average real income of the farmers of the United States 
in 1909, expressed in monetary terms, as $724. This was 
after some twelve years of slowly rising agricultural prices 
and improving conditions. The estimated value of all 
products, whether sold or used by the farmer, plus the 
value of his house rent and fuel consumed by family, was 
$1236, from which expenditures of $512 are deducted for 
outside labor and for materials used for operating and main- 
taining the farm. Of the $724 the sum of $402 is estimated 
to be the labor income of the family and $322 is estimated to 
be the wealth income (at 5 per cent of the capitalization of 
the farm). This was in a period of rising values in farm- 
lands, averaging about $323 per farm annually, and this 
to most farmers was equivalent to so much monetary savings. 
Main items of net income, 
Rent $125 

Food from the farm 261 

Fuel 35 

Cash 303 



Total $724 

Increase in value of farm 323 



Total estimated monetary income $1047 

Labor income $402 

Wealth income 322 

Capital income 323 



$1047 

Of the total $402 is a labor income, and 645 is a funded in- 
come.^ 

5 See Vol. I, p. 225, and note 11. 



Ch. 26] AGRICULTURAL AND RURAL POPULATION 453 

It would be difficult, even if the available statistics were 
much more exact than they are, to compare exactly the farm- 
er's income with those of urban classes. Averages of such 
large numbers and over such a wide area have a limited sig- 
nificance in the specific case ; and living conditions and the 
purchasing powder of money are veiy different in country and 
city and in different parts of the country.^ 

§ 11. Compensations of the farmer's life. In bare mone- 
tary terms the average farmer's family gets a labor income 
less than that of the ordinary wage-earner in a factory, and 
it is only when the value of the wealth income is added that 
it is as great. Even the few largest incomes made in 
farming are small in comparison with many of those made 
in commerce, transportation, and manufacturing. The great 
mass of farmers of the nation are hard-laboring men, poor in 
the eyes of the city dwellers.'^ 

But this much is certain : the farmer 's income in monetary 
terms has, on the average, much larger power to purchase the 
main goods of life (material and psychic goods) than it would 
have in town. Equally good house usance would cost more 
in nearly all towns, and much more in larger cities. Retail 
prices of the same food and fuel even in small towns would 
be much greater. The necessary outlay for clothes to main- 
tain the class standard is much less for farmers than for city 
dwellers. JMoreover, in the use of horses and carriages, and 
now of automobiles, and in the free control of his own time 
— in many elements of psychic income — the farmer is on a 
parity with men in other occupations of double or quadruple 
his income expressed in monetary terms. 

Though the farmer's working-day in the busiest season of 

6 See Vol. I, p. 206. 

" See Vol. I, p. 227, note, for figures on owners and farm laborers. 



454 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

summer is very long compared with that of factory or office 
workers, his working day at other seasons is usually much 
shorter than the average urban worker's day. The farmer's 
life is nearly always free from the excessive pressure, haste, 
and competition of city life, and the value, to many a man, of 
the more natural and wholesome conditions of outdoor life 
and outdoor work are hardly to be measured in terms of even 
the most untainted dollars. The joy and pride of possession 
that goes with even a little plot of ground and a house 
that is one's own, the satisfaction of "being one's own boss," 
the very real and deep sense of workmanship and of independ- 
ence that comes from planning and carrying through even 
simple tasks, rather than in acting under the orders of others 
— these are motives, not easily measurable in money, which 
keep many men on farms despite the temptations of higher 
financial rewards in cities. 

Many mistaken ideas are current among city folk in re- 
spect to country life, and much mistaken sympathy is wasted. 
The city man, living on external excitements, speaks with 
dread of the solitude of the country life, with no "movies" 
just around the corner and no Coney Island near. But he 
forgets that the people living in the country as real farmers 
were, with few exceptions, born and reared in the country. 
Families in the country average larger than in the cities, 
and the country has a rate of natural increase greater than 
the city. Persons raised in the country prefer to stay there, 
if they can make a living, a preference that tends to depress 
labor incomes in the country. The interests that fill the 
lives of country people are not the .same as those of city 
people, but they are often far more real. I know a farmer- 
boy who when ten years old refused a ticket to the circus 
because he preferred to help on threshing day ; and he and 
his brother probably have had more pleasure breaking and 
driving a yoke of calves to a homemade cart than any family 
of city boys ever got riding the elephant at the zoo. The 
non-pecuniary compensations in farm life help to outweigh 



C'H. 26] AGRICULTURAL AND RURAL POPULATION 455 

larger pecuniary rewards in manufacturing, transportation, 
mining, and trade, and prevents the rural exodus from being 
as great as it would otherwise be. In consequence the price 
of food is kept at relatively low levels, giving to the farmer 
and his family lower average monetary labor incomes than 
those earned in city occupations (organized or unorganized). 
§ 12. Ownership and tenancy. Since 1880, when the 
first figures on farm tenures were collected, the propor- 
tion of farms operated by owners has steadily decreased. 

Percentage of farms operated by 
Owners Cash tenants Share tenants 

1880 74.5 8.0 17.5 

1890 71.6 10.0 18.4 

1900 64.7 13.1 22.2 

1910 63.0 13.0 24.0 

These statistics arouse fears that the class of independent 
farmers operating their own farms is gradually giving way 
to a tenantry in America. But in some respects the figures 
are misleading unless carefully interpreted. The increasing 
proportion of tenants is due not so much to owners falling 
into the class of tenants as to the hired laborers rising into 
the class of tenants. The proportion of male operating own- 
ers to all male workers on farms has remained almost constant 
at about 42 per cent ; while hired workers have decreased from 
43.3 (in 1880) to 41.4 (in 1890) and to 34.6 (in 1900). Most 
hired men on farms are farmers' sons; the city boy does not 
adapt himself readily to farm work. Most hired men of 
native stock become tenants, and finally owners. Only 11 
per cent of the hired workers in agriculture (in 1900) were 
over thirty-five years of age. 

The landlord of a farm let to a tenant, especially to a share 
tenant, is still to a large extent the general manager, con- 
trolling in a large measure, through the renting contract and 
by his oversight, the operations of the farm. Older men find 
that letting the farm to a share tenant is easier for them and 
gives better results than continuing to operate the farm with 



456 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

hired labor. And it evidently gives a man a somewhat higher 
status to become a tenant than to continue to be a hired 
laborer. In the South this movement has taken on large pro- 
portions in the breaking up of large plantations once operated 
by the owner with hired labor, and now let in smaller lots to 
operating tenants. Yet such a change appears, statistically, 
as a decrease in the proportion of farms operated by owners. 
Despite these somewhat reassuring facts, the problem of main- 
taining and increasing operating ownership of farms in Amer- 
ica is one deserving of the most earnest thought and effort. 
The best form of farm tenure is not necessarily that giving the 
best immediate economic results. Politically in a democratic 
nation, and sociologically in its effects upon the size of fam- 
ilies and the raising of healthy children, the preservation of 
an independent American yeomanry is of fundamental im- 
portance to the nation. 

The problem is as difficult as it is important, and becomes 
more difficult with the rise in the acreage value of lands and 
with the economical size of farms, both calling for a larger 
investment to become an owner. Changes in the system of 
taxation should be made with reference to this object; the 
system of agricultural credit should be developed and admin- 
istered to assist; special efforts in agricultural education 
should be made and active administrative efforts should be 
directed toward this important end. 

References. 

Benton, A. H., Farm tenancy and leases. Agricultural Experiment 

Station Bulletin, No. 178. 1919. 
Carver, T. N., Selected readings in rural economics. Bost. Ginn. 

1916. 
Mead, E., Helping men own farms. N. Y. Macmillan. 1920. 
Nourse, E. G., Agricultural economics. Chicago University Press. 

1916. (A large volume of readings, well selected and edited.) 
Phelan, J., Readings in rural sociology. New York. Maemillan. 

1920. 
Taylor, H. C, Agricultural economics. Pp. 439. N. Y. Maemillan. 

1919. 
Vogt, P. L., Introduction to rural sociology. Pp. 443. N. Y. Ap- 

pleton. 1917. 



CHAPTER 27 



PROBLEMS OF AGRICULTURAL ECONOMICS 

§ 1. Size of farms, and total farming area. § 2. Influences acting 
upon the size of farms. § 3. Self-sufficing versus commercial farming. 
§ 4. Farming viewed as a capitalistic enterprise. § 5. Diversified 
versus specialized farming. § 6. Conditions favoring diversified farm- 
ing. § 7. Intensive farming in Europe and America. § 8. Prospect of 
more intensive cultivation of land in America. § 9. The new agricul- 
ture. § 10. Difficulty of cooperation among farmers. § 11. Rapid 
growth of farmers' selling cooperation. § 12. Some economic features 
of farmers' selling cooperation. § 13. Cooperation in buying. § 14. 
Need of agricultural credit. § 15. Provisions for farm loans. § 16. 
Need of an agricultural policy. 

§ 1. Size of farms, and total farming area. The average 
area of farms ^ has varied from a maximum of 203 acres in 
1850 (the first figures) to a minimum of 134 acres in 1880, 
being 138 acres in 1910. A better index, perhaps, is the 
average improved area per farm, which has been more nearly 
stationary, varying from a maximum of 80 acres in 1860 to a 
minimum of 71 acres in 1870 and 1880, being 75 acres in 
1910. Here again the statistics require interpretation, for in 
the spread of the frontier the addition of large farms in the 
arid and semi-arid regions may raise the average, or the break- 
ing up of large plantations in the South may decrease the 
average, without this indicating any essential change in the 
technical conditions of farming in the country generally. 

1 A farm is defined for census purposes as "all the land which is di- 
rectly farmed by one person, either by his own labor alone or with the 
assistance of members of his household, or hired employees. When a 
landowner has one or more tenants, renters, croppers, or managers, the 
land operated by each is considered a farm." 

457 



458 PUBLIC POLICY TOWAED PRIVATE INDUSTRY [Pt. V 

Since about 1900 tlie total area in farms has increased very 
slowly. Between 1900 and 1910 the increase was only 4.8 per 
cent; whereas a larger increase occurred in the area of im- 
proved land, 15.4 per cent, and the improved area in farms 
decreased 5.6. Future changes of farm areas may be expected 
to be of this same nature, mainly in the improvement of rough 
pastures, swamps, partly cleared woodlands, and desert lands 
awaiting irrigation. An increasing population will have to 




Fig. I, Chapter 27. Acreage of Com. 
Note: Now king of all crops, in value equal to that of cotton and 
wheat combined. Generally cultivated in eastern half of country. 



be provided with food and other products of agriculture on a 
farming area that henceforth will be increasing less rapidly 
than it has in the past and than the population increases. 

§ 2. Influences acting upon the size of farms. In these 
averages for the whole country many conflicting influences 
unite and neutralize one another. Making for smaller farms 
is the breaking up of large grazing areas in the West into 
smaller general-purpose farms or irrigated fruit districts, and 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 



450 



of larger general farms in the North and East into small poul- 
try, flower, and fruit farms. Opposed to this is a movement 
toward the merging of farms of 50 to 100 acres into larger 
farms of 300 acres, more or less. The economic cause of this 
movement is interesting and important. The typical and eco- 
nomic size of farms when the Atlantic states were settled was 
determined by the use of hand tools, which permitted a man 
and his family to operate a farm of about 75 acres, of which 
about half was tilled and the rest was in permanent pasture 







TED STATES 
COTTON 
ACREAGE 1909 

DOT REPRESENTS 
6 000 ACRES 



Fig. 2, Chapter 27. — ^Acreage of cotton. 

Note: Second in value among farm crops, but limited to a region 
less than a fourth of the whole country. Some production in the three 
states west of Texas is not shown on this map. 

and woodland. The fields were small and were laid out irreg- 
ularly, which was no disadvantage for hand cultivation. But 
for the most economic use of land in field crops and under 
more modern conditions it is necessary to have pretty level 
fields, of regular rectangular shape. The farm unit should 
be of such extent as to permit of the proper use of the soil by 
rotation of crops, and to employ fully the best modem labor- 
saving machinery for each purpose. Numerous recent agri- 
cultural survej'^ point to the conclusion that for general farm- 



460 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

ing this unit is a comparatively large area of about 300 acres. 

These conditions offer a reward to those agricultural enter- 
prisers who can purchase lands at a price based upon the 
high costs and lower yields of the older methods and cultivate 
them at the lower costs and with the larger yields of the newer 
methods. This movement, therefore, toward the consolida- 
tion of smaller into larger farms is likely to continue in many 
communities for several decades. This is likewise an ad- 
vantage to the community in increasing the production with 
less labor. But the net effect upon the social life of the 
countryside is more doubtful, and calls for careful consider- 
ation. 

§ 3. Self-sufficing versus commercial farming. The typi- 
cal American farming family once produced nearly every- 
thing it used, and used nearly everything it produced. It 
was very nearly a self-sufficing economic unit, a "closed 
economy," as it is sometimes called. Food, clothing, fuel, 
lumber, houses, furniture, tools, were on the farm carried 
through the various processes from the first gathering of the 
raw materials to the finished product. They were then con- 
sumed by the farm household. It is true that even in the 
first settlements there were some craftsmen — cobblers, millers, 
weavers, blacksmiths — whose services and wares were got by 
trading some of the surplus products from the farms — butter, 
cheese, eggs, wool, hides, furs, live stock, grain, lumber. A 
few rare commodities of foreign make found their way to the 
farm through peddlers and merchants; but altogether the 
goods produced outside the farm were a small fraction of the 
family's consumption, and were exchanged, for but little of the 
farm's production. Most farmers tried to produce for them- 
selves, as far as possible, everything their families needed, 
even when the soil and situation were poorly suited to the 
purposes. True, there were early some exceptional cases 
in which only one kind of product was taken from the 
land. Such were the forest products of masts, shingles, lum- 
ber, and turpentine, and the great southern staple, tobacco, 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 



461 



and later cotton. The exceptions have been tending to 
become the rule in more and more communities. Farmers 
have been specializing more and more in the kinds of prod- 
ucts to which their farms are adapted in respect to soil, rela- 
tion to market, and otherwise. These products are taken to 
market and sold for money with which are bought the things 
needed for use on the farm. 

§ 4. Farming viewed as a capitalistic enterprise. Thus 



WHEZAT 




Fig. 3, Chapter 27. — Production of wheat. 

Note: Largely produced in a comparatively restricted wheat belt 
bordering tie semi-arid region; elsewhere mainly a rotation crop. 

the farm comes to be looked upon more and more, not merely as 
a home, but much as if it were a commercial enterprise or a 
factory, by which products are made for sale. This change, 
to be sure, is far from complete, as the figures for the average 
farmer's income show that a large share of the family living 
still comes from the farm. It has gone on much further in 
some districts than in others, as is indicated in the types of 
farming discussed below. But, just to the extent that the 
farmer grows crops to sell, his outlook on his work undergoes 



462 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

a change. He is less exclusively a farmer, concerned with 
the technical processes of farming; he must be more largely 
a business man. Like a manufacturing enterpriser, he buys 
the factors of production, combines them into new products, 
and sells them again. He becomes interested in market con- 
ditions and prices. He grows more commercially minded. 
He views the farm no longer as a fixed area, but one that may 
be enlarged by purchase or by rental, and that may be reduced 
by selling or letting the less needed parts. One fifth of farm- 
owners now rent additional land. In commercial farming the 
land is not contrasted with capital as something apart, consist- 
ing of the value of the equipment and stock; but the whole 
complex of land and other goods is thought of as a capital 
investment. The greater ease of tranf erring landed property 
in America and the greater mobility of our population have 
always made it more natural here than in Europe to look 
upon land as a capital investment. This view is now becom- 
ing more general as a result of the commercializing of farming 
enterprise. 

This change has been favored by other influences. Partic- 
ularly has the use of machinery and of other equipment, 
calling for a larger investment per man and per acre, been 
making agriculture, in its form of enterprise, more like manu- 
facturing and commercial undertakings. 

§ 5. Diversified versus specialized farming. To be 
largely self-sufficing a farming family must carry on general 
farming, that is, must produce a diversitj^ of products. As 
farming becomes more commercialized it usually becomes more 
specialized, and a certain district produces a smaller variety 
of products. In some part of the country and on particular 
farms this specialization is extreme : In various parts of Cali; 
fornia, citrus fruits or prunes or beans may be the only crop 
raised ; wheat in central Kansas and the Dakotas ; fresh milk 
and vegetables on thousands of farms surrounding the great 
cities; cotton in many parts of the South. Many farmers in 
these districts have no gardens or orchards, keep no cow, and 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 



4G;5 



buy much or all of the grain for their horses, as well as milk, 
butter, vegetables, and fruit for their own use. Poultry and 
eggs are shipped in trainloads two thousand miles from the 
IMiddle West to California to be consumed by orange-growers. 
Many farmers in the East no longer keep sheep, pigs or beef 
cattle, and they buj- out of the butcher's wagon all the meat 
except fowls used by their families. This partly explains the 
decrease of live stock in the whole country in recent years and 
the relative increase in the price of meat. 




Fig. 4, Chapter 27. Dairy products. Observe the close relation with 
manufactures in Fig. 3, ch. 26. 

§ 6. Conditions favoring diversified fanning. There are 
however, limits to the net advantage of specialization in crops, 
and competent authorities on agriculture question whether in 
many cases that limit has not been reached and passed. Most 
farms have a variety of soils and conditions — hilltops, slopes, 
bottom-lands — w^hich are suitable for different purposes. A 
rotation of crops is necessary to get good yields. Live stock 
must be kept to maintain the fertility of the land, which de- 
teriorates fast if hay and grain are continually sold. Some 



464 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

live stock can be kept on every farm very cheaply with the 
food that would go to waste otherwise. The specialization 
in stock-raising in the prairie states ceased to be profitable 
when lands became more valuable. Specialization in wheat 
production in the states just west of the Mississippi is possible 
only as long as wheat will grow on the virgin soil without 
costly fertilizers. The cotton farmers of the South, especially 
the negro-farmers, have been forced by debt and thriftlessness 
into a one-crop policy that is now seen to be wasteful in the 
long run. A variety of production is necessary to employ 
labor somewhat regularly on a farm throughout the year. 
These and other conditions will make most farming always 
an industry of comparatively diversified products. Only 1 
per cent of the farms get as much as 40 per cent of their 
receipts from fruit ; 2 per cent get that much from tobacco ; 
3 per cent from vegetables; 6 per cent from dairy products; 
and 19 per cent from cotton. The remaining 64 per cent of 
receipts are in most cases from various sources, and these 
figures do not include the value of produce consumed by the 
farmer's family. 

§ 7. Intensive farming in Europe and America. No 
other farm problem interests the city man so much as that of 
increasing the production of the land. To most city men 
farming hardly seems to be an occupation giving livelihood 
and life to the farmer; it seems rather to exist for the sole 
purpose of feeding men living in cities. The city man, there- 
fore, measures the success of farming, not by the farmer's 
income or by the level of the countryside prosperity, but by 
the number of bushels per acre raised to ship to town. Every 
city newspaper and magazine contains articles pointing to the 
fact that larger crops per acre are raised in Europe than in 
America, and broadly suggesting that the American farmer 
could do as well, if only he would. Foreign travelers com- 
ment in like vein on the wasteful use of land in America 
as compared with farming methods in Europe. 

Land is used most extensively, with respect to labor, when 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 4G5 

it is iu forests ; somewhat less so when in pasture, as care must 
be given to the live stock; and still less when used for hay, 
grain, and other crops. But cultivation with machinery in 
large fields is a far more extensive method of agriculture than 
that carried on by the patient work of peasants with their 
hand tools. The more labor or the more equipment (or both 
together) that is put upon an acre, the larger the product, 
but the larger the cost per unit. It is a familiar economic 
principle.^ It would bankrupt any farmer, excepting the 
millionaire amateur, to farm in America, by European 
methods. American farmers, at least many of them, could 
raise as many bushels per acre and keep their farms as thor- 
oughly cultivated as do the European peasants, if wages were 
as low here as are the peasants' incomes. 

§ 8. Prospect of more intensive cultivation of land in 
America. As the aggregate need for food increases in 
America there must come a steady pressure upon our stock 
of land uses, resulting in decreasing returns to labor in ag- 
riculture, unless this movement can be counteracted by the 
spread of better methods in agriculture — not European peas- 
ant methods, but new American methods consistent with 
high .labor incomes. A good deal of our farm land is un- 
doubtedly too intensively used now in view of present and 
prospective commodity prices and wages. ^Maladjustment of 
land uses has resulted from mistaken judgment, from chang- 
ing conditions as to prices, transportation, and markets, 
and from loss of soil fertility. There are thus, on nearly 
every old farm, some fields that would better be in pasture and 
much hillside pasture that would better be woodland. It is 
often declared extravagantly that our country could support 
easily the total population of China, or as great a population 
per square mile as that of Italy. If it did so it would be only 
on the penalty of lowering wages toward, if not quite to, the 
level of the Chinese coolie or of the Italian peasant. Great 

2 See Vol. I. chs. 12 and 13, on proportionality and usance. 



466 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

metropolitan dailies gravely present, as an argument in favor 
of unrestricted immigration, the proposition that *4f" the 
cheaper immigrants would but go upon our ''waste" land 
(which they refuse to do), and raise food by European 
methods, the problem of the rising cost of food in the cities 
would be solved. This urban ideal of a frugal, low-paid 
agricultural peasantry can hardly be adopted in America as 
the national ideal. Eather, it would seem, any movement to- 
ward more intensive agriculture that necessitates a lowering 
of the standard of living of the masses of the American people 
will, when it is recognized, be condemned and opposed. 

§ 9. The new agriculture. Agricultural method, the 
technic of farming, has been constantly progressing for two 
hundred years in Europe and in America. Were it not for 
this, the great growth of population on this combined area 
iwould have been quite impossible. But the betterments since 
about 1890 in America have been especially great. They are 
mostly the first large fruits of the scientific study made pos- 
sible by the land-grant colleges and agricultural experiment 
stations fostered by state and national legislation. These 
many diverse improvements are grouped under the general 
title of the "new agriculture." Its chief features are: new 
machinery and other labor-saving methods ; better methods of 
cultivation of the soil ; better selection of seed ; introduction of 
new plants and trees from abroad to utilize low-grade lands; 
plant-breeding to develop new varieties of better quality, 
heavier bearing, or immune to disease; more efficient and 
economical ways of maintaining soil fertility ; better methods 
of marketing ; and better technical education of the individual 
farmer. Each of these topics, and a number of other minor 
ones, wou^M require a chapter in a complete treatise on agri- 
cultural economics. Here this mere enumeration must be 
allowed to convey its own suggestion of far-reaching results 
for the whole political economy of the nation and of the world. 

Indeed, so much has been written in a Barnumesque way of 
the wonders of the new agriculture that its actual results and 



Ch. 27] PROP.l.Kr^rS OF AGRICULTURAL ECONOMICS 467 

further possibilities are in nvdnj minds absurdl}^ exaggerated. 
It has not as yet been potent enough to prevent diminishing 
returns in respect to the great staple foods and raw materials 
obtained by agriculture. It apparently has barely kept pace 
with the needs of the growing population of Christendom. 
It has enabled a larger population to exist in about the same 
if not in a worse condition, on the same area, while progress 
in cheapness of goods has come almost entirely from the side 
of the chemicail and the mechanical industries. It does not 
give the promise of an indefinite amelioration of the lot of an 
indefinitely multiplying population. But, to a population 
slowly increasing, a new and ever newer agriculture, utilizing 
constantly the achievements of the natural sciences and the 
mechanic arts, insures the possibility of a steady betterment 
of the popular welfare in city and in open country alike. 

§ 10. Difficulty of cooperation among farmers. Rural 
communities are proverbially conservative; the American 
farmer is proverbially an individualist. No wonder, theu, 
that the new ideas and plans of cooperation in business mat- 
ters have made headway in agriculture slowly and with dif- 
ficulty. The need of mutual aid among American farmers 
is especially great, for, as has often been said, isolation is the 
problem of the farm, as congestion is that of the city. On 
the frontier a cooperative spirit manifested itself frequently 
in mutual helpfulness, in house-raising bees, husking bees, 
threshing bees, and other similar gatherings. But this spirit 
seems to have almost disappeared in the older communities, 
the more rapidly doubtless in the period of decaying agricul- 
tural prosperity.^ To-day, for example, it is impossible on a 
certain Pennsylvania road for one more progressive farmer 
to get his neighbors to cooperate in so simple a matter as 
hauling their milk-cans to the creamery; and so every day 
in the year ten horses are hitched to ten delivery wagons, 
carrying two or three milk-cans apiece, and driven by ten 

3 See ch. 26, § 5 and § 6. 



468 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

drivers along the same road to and from tlie railroad station. 
One driver and two horses could easily carry as much or 
more, as is done now in many other dairy districts. Even of 
successful cooperation among farmers sjonpathetic critics are 
forced to say: "Many students of rural economics assert that 
cooperation as applied to the distribution and marketing of 
farm products is not very successful unless it is founded 
upon dire necessity. When the records of the organizations of 
the country are analyzed, it becomes almost necessary to 
accept that statement. As long as farmers do fairly well in 
their own way; they are not inclined to cooperate." 

§ 11. Rapid growth of fanners' selling cooperation. 
Despite what has just been said, cooperation among farmers 
now is more developed and is growing faster than all other 
kinds of cooperation in America. In 1920 there were at least 
14,000 farmers' buying and selling associations, distributed 
throughout every state in the union. Their growth has been 
most marked in farming communities in the "West, especially in 
California and in the middle western or northwestern states 
(e. g., Minnesota and Wisconsin). There the farmers average 
younger, and many have been educated in the state agricul- 
tural colleges. They all produce nearly the same kinds of 
crops of staple produce which must be shipped to distant 
markets. The need of uniting to get what they thought 
would be fair treatment from the railroads, and to protect 
themselves against the abuses of the competitive commission 
sales-agents, seems to have given the first impetus to farmers' 
cooperation. 

The most notable developments were those of the California 
Fruit Exchange and of cooperative societies of the North- 
west for marketing grain. The membership of the former 
is made up entirely of the local citrus-growers' associations 
in California. It has a complete organization of selling 
agents in the eastern cities, and a remarkably efficient, though 
simple, system of equalizing and expediting shipments. Agri- 
cultural cooperative associations of various kinds are mul- 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 469 

tiplyiug- all over the couiitiy, for shipping live stock, fruits, 
butter, cheese, and other farm products. Cooperation for 
these purposes called forth new activities ; packing-liouses were 
built, and grain-elevators and creameries and dairies, and 
now a goodly number of the simple manufacturing proc- 
esses are undertaken by these societies. 

§ 12. Some economic features of farmers' selling coop- 
eration. This type of producers' selling cooperation is prov- 
ing in America to be far more successful than producers' co- 
operation among workingmen;* and certain important eco- 
nomic features in it should be noted. The local producers' 
selling cooperative society is composed of farmers who as 
enterprisers own and carry on their own separate businesses ; 
the}' are not, as in the other case, wage-workers. Any pro- 
ductive processes undertaken by this kind of society are sub- 
ordinate to the main business, being such as picking, packing, 
drying, preserving, and making boxes for packing. This 
form of cooperation, with the related form of consumers' co- 
operation that is fostered by it, promises to have a wide ex- 
tension. 

Some of these societies, as those dealing in citrus fruits, 
regulate with some success the picking and the marketing so 
as to distribute them more evenly throughout the year. They 
watch the markets aiid direct their agents by telegraph to di- 
vert cars en route away from markets that are glutted with 
products and into markets where prices are higher. They take 
some of the products, as eggs in the spring at the period of low 
prices, and pack or refrigerate them, to be sold when prices 
are higher. For thus withholding the supply they are said by 
some to exercise a monopolistic power. But this is a more 
than doubtful view. As long as only the seasonal variations 
are equalized and the total supply of the year is not reduced, 
it is, on the marginal principle, an economic sendee to the con- 
sumers, comparable to insurance in its utility. Reducing the 

4 See ch. 20, §§ 13, 14, 15. 



470 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

area planted or preventing the entrance of others into the in- 
dustry would be monopolistic acts, but these as yet have not 
occurred. 

§ 13. Cooperation in buying. Cooperative buying (called 
also consumers' cooperation or distributive cooperation) has 
had a large growth in the British Isles since 1844, when the 
society called the Rochdale Pioneers was founded by a group 
of factory workingmen. The cooperative stores, both iri. 
Great Britain and on the Continent, have flourished mainly 
among the industrial workers in urban centers. However, 
this has not been exclusively the case, and, particularly in 
Denmark and Ireland, cooperative buying has increased in 
agriculture in connection with selling associations. Between 
1890 and 1914 the growth of consumers' cooperation among 
European industrial wage-earners was phenomenal, especially 
in Belgium, Germany, and Switzerland. American wage- 
workers however, have made few and feeble efforts in this 
direction. 

In the period beginning 1867 many cooperative stores were 
founded in America by farmers in the Grange movement, 
who operated also grain-elevators, warehouses, and steam- 
boat lines. But the movement failed, about 1877. This re- 
sult is easily explained by lack of commercial knowledge and 
lack of harmony among the members, selling on credit, and 
inefficient management. A new era in consumers' coopera- 
tion for farmers began about 1900, and in several widely sepa- 
rated parts of the country — ^Minnesota, Kansas, California, 
Washington and elsewhere — the movement has spread rap- 
idly, supported in large part by the same persons who are 
members of the selling associations. 

§ 14. Need of agricultural credit. Banking originated 
in cities and for the use of the merchant class. It still re- 
tains pretty faithfully its commercial character. The change 
of farming toward a more commercial form = has been little 



5 See above, § 3. 



J 



Cu. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 



471 



aided by banking credit. National banks and many others 
were forbidden in their charters to lend on the security of 
real estate, the farmer's one business asset.^ A great num- 
ber of farms are always in course of being purchased, the bal- 
ance of purchase money being borrowed by the purchaser. 
A group of private agencies, such as life insurance and mort- 
gage loan companies and local money-lenders, has supplied 



Farm Prices 



240- 
220- 
200- 
180- 
I«0- 
140- 
120- 
100- 





A 






=^^^^-^ — '''~" 


J'" 



-240 
-220 
-200 
-180 

- 160 

- 140 

- 120 

- 100 



Fig. 5, Chapter 27.— Farm prices, 1909-192L 

Note: The years 1917 to 1919 were years of exceptional prosperity 
for farmers, because the price of their products rose faster and higher 
than either farm wages or the prices of the things that farmers buy. 
The years 1920 and 1921 were disastrous. Farm products began to 
fall while nearly everything that the farmer had to buy kept on rising 
in 1920, and then fell in 1921, but less than did farm products. 

long-term farm credits at rates of interest considerably higher 
than were paid for loans on urban real estate. The total of 
agricultural loans was estimated in 1916 to be $3,500,000,000. 
Though rates of interest had become more equalized through- 
out the whole country, they still ranged between 7 and 10 per 
cent in the southern and western states, averaging 7 per cent 
in the whole country for interest and commission. The need 



6 See eh. 8, § 8. 



472 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

of better opportunties for credit in the agricultural districts 
was long recognized. The high rate of interest for borrowed 
money necessarily placed a limit on improvements in equip- 
ment and methods of farming/ 

§ 15. Provisions for farm loans. The Federal Reserve 
Act made two important changes to improve agricultural 
credit.® Long and vigorous discussion of the subject led at 
length to the enactment of the Federal Farm Loan Act, July 
17, 1916. It authorized the establishment of twelve Federal 
Land Banks, each with a capital of not less than $750,000, to 
make loans through national farm associations organized 
somewhat after the model of the building and loan associ- 
ations. The bonds issued by these banks may bear not to ex- 
ceed 5 per cent interest and are tax exempt. The loan is re- 
paid by the farmers under a regular plan of amortization. 

This plan went into effect opportunely, when the with- 
drawal of loans from America by European investors and the 
financing of the war was already causing rising interest rates. 
But for this act, the financial difficulties to agriculture would 
have been serious just as the patriotic slogan declared, "Food 
will win the war." As private investors were not ready to 
subscribe for stock in the banks, the Treasury of the United 
States did so. In the first year of its operation the Federal 
Farm Loan Banks issued nearly $100,000,000 of bonds ; and at 
the end of about three years (by October, 1920) more than 
$350,000,000 ; at which time farm loan associations to the 
number of four thousand were operating. Besides, there 
were operating under the act twenty-five Joint Stock Land 
Banks with mortgage loans of nearly $80,000,000 outstand- 
ing. 

AIL of the effects of this legislation are not yet fully appar- 
ent; but it is clear that it has brought down the rate of 

7 See Vol. I, pp. 495-497, on the relation between lower interest rates 
and productive processes. 

8 See eh. 9, § 7 on time deposits, and § 9 on farm loans. 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 473 

interest on long-time loans of farmers to nearly 5 per cent in 
the remotest parts of the countr3\ This must stimulate ag- 
ricultural improvement and make it possible for thrifty ten- 
ants to purchase land on long time. But, inasmuch as farm- 
lands are brought within the circle of lower interest rates, 
their capitalization will be higher, based on the net annual 
rental. But ultimately the law should, with wise administra- 
tion and careful changes made in the light of experience, 
broaden and strengthen the independent farm ownership of 
the nation, as well as increase agricultural production. 

§ 16. Need of an agricultural policy. Men of the 
farthest vision in the field of agricultural and land eco- 
nomics — men such as Liberty Hyde Bailey, chairman of the 
Roosevelt Country Life Commission, Eugene Davenport, 
director of the Illinois College of Agriculture, Kenj'-on L. 
Butterfield, president of the Massachusetts College of Agri- 
culture, and Richard T. Ely, founder of the Institute for Re- 
search in Land Economics — have since the beginning of this 
century been striving to gain for this great problem some due 
share of the national thought and effort. The events of the 
Great War gave force to their appeal for a national polic}' of 
agriculture. It is not too optimistic to believe that in some 
respects substantial progress toward this end has been made 
in the development of experiment stations and state colleges 
of agriculture, farmers' institutes, and "farmers' week" 
gatherings, that bring together the progressive farmers by 
thousands, not only to get some technical and practical hints 
on raising crops, but to gain a broader view of their economic 
task and of their civic responsibilities. These schools and 
meetings are helping, as are automobiles, good roads, tel- 
ephones, rural free delivery, better schools, and an active 
rural press, to destroy the isolation of country life and to 
make farmers as a class more broadly educated, more co- 
operative and more public-spirited than the average urbanite. 
More insistently the call is heard for a national policy in ag- 



474 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

riculture, with the belief that, more than any other occupation, 
agriculture is bound up with the very existence and survival 
of the nation. This belief rests not merely on the crude physi- 
cal fact that men must have food to live, but also, and even 
more, on the eugenic fact that whatever be the country pop- 
ulation will ultimately be the nation, and on the historical fact 
that democracy, stable government, and liberty must have 
their roots in the soil and in the ownership of homes. This 
and the foregoing chapter have but sketchily suggested some 
of the topics that make up the agricultural problems. It is 
even more important to appreciate that the agricultural prob- 
lem is connected with all the other industrial problems, and 
is but a part of the one greatest problem, transcending indi- 
vidual, class, and sectional interests, the problem of national 
welfare. 

References. 

Adams, G. 0., Commercial geography. N. Y. Appleton. 1906. 

Bruce, A. A., The Non-Partisan League Citizens Library Series. 
New York. Macmillan. 1920. (By a former Supreme Court Jus- 
tice of N. D. Picture of the econom.ic conditions leading to the 
formation of the Leagtie. ) 
. Ca/rver, T. N., Selected readings in rural economics. N. Y. Ginn. 
1916. 

Cumberland, W. W., Cooperative marketing; the advantages as 
exemplified in the California Fruit Growers Exchange. Prince- 
ton. University Press. 1917. 

Kemmerer, E. W., Agricultural credit in the United States. A. E. 
Rev., 2: 852-872. 

Marsh, G. P., Man and nature: or physical geography as modified 
by human action. N. Y. Scribner. 1864. (Later editions un- 
der the title, "The earth as modified by human action.") 

Marshall, L. P. and others, Materials for the study of elementary 
economics, 58-61 (extract from Mason, 0. T., Technogeography, 
or the relation of the earth to the industries of mankind. Ameri- 
can Anthropologist, 7-: 135-158. 1905) ; 61-66 (extract from 
Semple, E. C, Influence of geographic environment. 1911) 
Univ. of Chic. Press. 1913. 

PMllips, G. A., Readings in money and banking. Ch. XXVII. On 
agricultural credit. N. Y. Macmillan. 1916. 

Pope, J. E., The federal farm loan act. Washington. Bureau of 
applied economics: Department of banking and public finance. 
Pp. 58. 1917. 

Teele, R. P., Irrigation in the United States. N. Y. Appleton. 
1915. 



Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 475 

Warren, G. F., Farm management. N. Y. Macmillan. 1913. 

(Treats primarily the problem of the individual farm, but also 

many of the broader economic questions.) 
Weld, L. D. H., The marketing of farm products. N. Y. Macmillan. 

1916. 




f2i 



bD 



CHAPTER 28 



THE TRANSPORTATION PROBLEM 



§ 1. Natural waterways. § 2. The era of canals. § 3. Temporary 
wreck of inland water transportation. § 4. Rapid building of American 
railroads. § 5. Eras in the railroad problem. § 6. Governmental aid 
to railroads. § 7. Emergence of the railroad problem. § 8. Discrim- 
ination as to goods. § 9. Local discrimination. § 10. Personal dis- 
crimination. § 11. Economic power of railroad managers. § 12. Polit- 
ical power of railroad managers. 

§ 1. Natural waterways. In the simplest economic con- 
ditions the moving of men and their material goods from one 
place to another was a very important part of economic ac- 
tivity. Our elementary studies make clear that place change 
may be just as real and effective a way of increasing the 
value of goods as is form, stuff, or time change. Tens of 
thousands of years ago savage men began to supplement their 
comparatively weak powers as burden-carriers by using 
domestic animals, and to find other aids for carrying burdens 
in such instruments as yokes, litters, rafts, canoes, drags, and 
rude wheeled carts. Boats and ships on rivers, lakes, and 
seas early proved to be the least costly means of transpor- 
tation for heavy weights and long distances ; as the old saying 
goes, the oceans unite rather than divide the lands. Other 
means of transportation were naturally the shortest and most 
easily traversed caravan routes to navigable water, or portages 
between two waterways. A good system of natural water- 
ways, while not reckoned among the private capital of a 
country, may be greater wealth to one nation than costly arti- 
ficial means of transportation are to another. 

In natural means of transportation, America was well en- 

477 . 



478 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

dowed. The straight ocean coast-line measures 5700 miles, 
and the line following indentations of the coast is about 
64,000 miles. The Great Lakes, with a straight shore-line of 
2760 miles, art; the most important inland waterways in the 
world. The 295 navigable rivers in the country have a length 
of 26,400 miles that might be navigable water. 

The natural conditions of transportation and primarily the 
location of the navigable waters of oceans and rivers, deter- 
mined entirely the location of industries and the .spread of 
population in America until the eras of canals and railroads. 
The success of Fulton's steamboat in 1807, indeed, so in- 
creased the importance of our natural inland waterways that 
they were the dominating feature of transportation in many 
parts of the country until after the Civil War. The successive 
rise in importance, however, of two artificial kinds of trans- 
portation is indicated by the terms * ' era of canals ' ' and ' ' era 
of railroads. ' ' 

§ 2. The era of canals. Canals were used in the ancient 
empires for irrigating, for the supplying of cities with water, 
and for navigation. In the late eighteenth and the early 
nineteenth centuries they were rapidly built in England and 
America. Six canals had been built in the United States 
before 1807, but the canal era in America dated from the 
beginning of work on the Erie Canal in 1817, and continued 
until about 1840 ; when nearly all new work ceased ; more than 
4000 miles of canals had been built at a cost of $200,000,000. 
The New York State barge canal, costing more than 
$150,000,000, the most notable of our inland waterways, 
was opened for navigation May 10, 1918.. It is, the old 
E»ie Canal, reconstructed to permit the passage of thousand- 
ton barges. The great advantage of canals is cheapness of 
operation due to the simplicity of the machinery needed 
and to the great loads that can be moved with small power. 
A cent a ton-mile proved to be a paying rate on a small 
canal in the canal era. For heavy, slow-moving freight, a 
railroad can even now barely rival a parallel canal at its 



Ch. 28] THE TRANSPORTATION PROBLEM 47i) 

best. As canals, however, can be built only along fairly- 
level routes and where the water supply is at high level, 
their construction is limited to a small portion of the coun- 
try. The principle of diminishing returns applies strongly 
to the construction of canals : the first canals in favored loca- 
tions are easily constructed and economically operated, but 
it is only with greater cost and difficulty that the system 
can be successively extended. In temperate climates the use 
of canals is limited by ice to a part of the year, and by the 
summer 's drought sometimes still further. At its best, there- 
fore, the small land-locked canal is fitted only to be a supple- 
mentary agent in the system of transportation wherever an- 
other transportation agency of higher speed and greater regu- 
larity is possible. Far different is the case of the oceanic 
canal in a tropical climate. 

Canals do not appear to have developed many serious prob- 
lems calling for public regulation. A first simple legislative 
act fixing the rate of tolls for boats was sufficient; Charges 
were made by distance as on a toll road, and the boats were 
owned by different private shippers or by common carriers 
among whom competition prevailed. 

§ 3, Temporary wreck of inland water transportation. 
After the sudden check to canal-building about 1840, most 
of the existing canals continued to operate, with slowly de- 
clining prosperity, until after the Civil War, when many 
of them were abandoned. The reasons for their failure can 
be understood only in connection with the history of the 
railroads in that period. There was not enough traffic for 
both water and rail carriers to thrive, and, at every point 
where canals or rivers and railroads touched or were 
parallel, railroad rates were cut below average rates, or tem- 
porarily even far below the cost of carriage. The shipping 
on the Great Lakes was the one form of inland iwater trans- 
portation to survive and flourish. 

This wreck of the canal and the river carriers ruined the 
prosperity of great numbers of business enterprises and of 



480 PUBLIC POLICY TOWAKD PRIVATE INDUSTRY [Pt. V 

whole regions, while artificially favoring other enterprises 
and locations. In the long run (that is, forty or fifty years 
after it had been done), especially when traffic had so in- 
creased that the railroads were inadequate to care for it, 
this was seen to have been unfortunate for the country as 
a whole, "Water transportation has its rightful place along 
with railroads in a general system of transportation, each 
agency to be used in the places and for the kind of traffic 
for which each is best fitted. The restoration and develop- 
ment of our inland waterways is one of the large transporta- 
tion problems awaiting solution in the second quarter of the 
twentieth century. 

§ 4. Rapid building of American railroads. The canal 
was just reaching the peak of popular favor when the rail- 
road in 1830, after a half-century of slowly accumulating 
technical improvements, burst into view as a demonstrated 
success as a means of transportation.^ The railroad excels 
in adapt ahility any other agent of transportation; it can go 
over mountains or tunnel through them. It is markedly su- 
perior in certainty; it may be blocked for a day or two by 
floods and snows, but it suffers no seasonal stoppage of traf- 
fic. In speed, even the early railroad so far excelled that the 
canal could survive only by dividing the traffic, taking the 
lower grades of freight, and leaving to the railroad the pas- 
senger traffic and fast freight. Although in respect to cheap- 
ness, it could not equal the waterways in favored localities 
the railroad made rapid gains, and improvements in road-bed, 
rails, cars, engines, and other equipment soon reduced greatly 
the cost of conducting traffic on the main lines of roads. Be- 
cause of these qualities railroads soon surpassed in impor- 
tance every other agency of internal transportation. The 
miles constructed and miles in operation in the United States, 
by decades since 1830, were as follows (route mileage, not 
counting double tracks and sidings) : 

1 See A. T. Hadley, "Eailroad Transportation," pp. 10, 32. 



Ch. 28] TPIE TRANSPORTATION PROBLEM 481 

in decade Total route miles 

Miles constructed in operation 

1830 23 23 

1840 2,795 2,818 

1850 6,203 9,021 

I860 21,605 30,626 

1870 22,296 52,922 

1880 40,345 93,267 

1890 73,924 167,101 

1900 31,773 198,964 

1910 51,028 249,992 

1915 (5 yrs.) 13,555 263,547 

1918 (3 yrs.) 2,798 264,233 2 

The extension of railroads was so rapid that there was not 
time for a ^adual adjustment of industrial conditions. In 
many places the resulting changes were revolutionary. The 
building of railroads in the Mississippi Valley in the seventies 
lowered the value of eastern farms, ruined many English 
farmers, and depressed the condition of the peasantry in all 
western Europe.^ With the lower prices that resulted when 
the fertile lands of the western prairies were opened to the 
world's markets, the less fertile lands of the older districts 
could not compete. Many other changes, of no less moment 
in limited districts, resulted from the building of railroads. 
Local trading centers decreased in importance. Villages and 
towns, hoping to be enriched by the railroads, saw their trade 
going to the cities. Commerce became centralized. Enor- 
mous increases of value at a few points were offset by losses 
in other localities. 

§ 5. Eras in the railroad problem. The history of rail- 
roads in the United States is closely interwoven with the 
general economic development, the political ideas, and the 
public opinion of the nation from 1830 to the present time. 
Despite the absence of clean-cut unified public convictions 
on the subject, the entire period divides into fairly well 

2 In this period the mileage abandoned on small and non-paying roads 
partially offset the new mileage constructed. 

• See Vol. I, pp. 437, 438, 443. 



482 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

marked eras, as new ideas and policies dominate, not entirely 
displacing the old, and already foreshadowing still others. 
These eras may be designated as follows: 

(1) Unregulated private enterprise, beginning 1830. 

(2) Ineffective state regulation, beginning about 1870. 

(3) Ineffective federal regulation, beginning 1888. 

(4) Strong federal regulation, beginning 1906. 

This latest era exhibits already two phases, the first being 
from 1906 to the war in 1917, and the second after that 
time. The history of these successive eras is instructive to 
the student of economic institutions in America, as showing 
how in a democratic society definite truths displace vague 
and mistaken opinions after long and bitter experiences. 

§ 6. Governmental aid to railroads. The growth of rail- 
roads in America was more rapid than in any other part of 
the world, but it did not occur without much help to private 
capital from governmental agencies. The railroad enter- 
prise was uncertain, the possibilities of its growth could not 
be foreseen, and private capital would not invest without 
great inducements. In European countries the railways 
were built through comparatively densely populated districts, 
to connect cities already of large size. Yet railroad exten- 
sion was very slow there, even though the states in many ways 
aided the enterprises. America was comparatively sparsely 
populated, and most of the railroads were built in advance 
of and to attract population, business, and traffic. In many 
cases railroad-building in America was part of a gigantic 
real-estate speculation undertaken collectively by the tax- 
payers of the communities. 

American states recklessly abandoned the policy of non« 
interference, and vied with one another in giving railroad 
enterprises lands, money, and privileges, in lending bonds, in 
subscribing for stock, and in releasing from taxation. These 
fostering measures were expected to increase wealth and to 
diffuse a greater welfare throughout the community. Many 



Cir. 28] THE TRANSPORTATION PROBI.EM 483 

states were forced to the point of bankruptcy by their reck- 
less generosity, and some states repudiated the debts thus 
incurred. 

The national government then took up the same policy and 
granted lands to the states to be used for this purpose. The 
first case of this kind was the grant to the Illinois Central 
road, in 1850, of a great strip of land through Illinois from 
north to south. Grants were made in fourteen states, cover- 
ing tens of millions of acres of land. Then the national gov- 
ernment, between 1863 and 1869, aided the building of the 
Pacific railroads by granting outright twenty square miles 
of land for every mile of track, and by lending the credit of 
the government to the extent of fifty million dollars — a debt 
that was settled by compromise only after thirty years. 

Counties, townships, cities, and villages then entered into 
keen competition to secure the building of railroads, pro- 
jected by private enterprise. Bonds, bonuses, tax-exemp- 
tions, and many special privileges were granted. To obtain 
this new Aladdin's lamp, this great wealth-bringer, localities 
mortgaged their prosperity for years to come. The promoters 
bargained skilfully for these grants, playing off town against 
town, cultivating the speculative spirit, punishing the ob- 
durate. Not the civil engineer but the railroad promoter 
determined the devious lines of many a railroad on the level 
prairies of America. The effects of these grants were in many 
cases disastrous, and after 1870 they were forbidden in a 
number of states by legislation and by constitutional amend- 
ments. But, before this era of generosity ended, the rail- 
roads in America had received probably more public aid than 
has ever been given to any other form of industry in private 
hands. 

§ 7. Emergence of the railroad problem. In most cliar- 
ters and laws authorizing the building of railroads, either 
nothing was specified regarding rates, or maximum rates 
were fixed which proved to be so high that they were of 
little, if any, practical effect. But very soon began to appear 



484 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

some serious evils in the policy of railroads toward the ship- 
ping and traveling public in matters of rates and of service. 

As the ownership of the wagons, ships, and canal-boats of 
a country is usually divided, ocean ports and points along 
the lines of turnpikes and canals enjoy competition between 
carriers. In the early days of the railroads it was believed 
that a company or the government would own the rails and 
charge toll to the different carriers, who would own cars and 
conduct the traffic, as was done on the canals. Experience 
soon showed the impracticability of this scheme and the need 
of unified management. An operating railroad company, 
therefore, has a monopoly at all points on its line not touched 
by other carriers. This, like any other monopoly, is limited; 
for the railroad, to secure traffic, is led to meet competition of 
whatever kind — that of wagons, canals, rivers, or of other 
railroads — wherever it occurs. The railroads in private 
hands early began to "charge what the traffic would bear," 
high where they could and low where they must, to get the 
business. Thus developed the various forms of discrimina- 
tion. 

§ 8. Discrimination as to goods. Discrimination as to 
goods is charging more for transporting one kind of goods 
than for another, without a corresponding difference in the 
cost. When reasonably understood, this proposition does not 
apply to a higher charge for goods of greater bulk, as more 
per pound for feathers than for iron, the ''dead weight" of 
car being much greater in one case than in the other. It 
does not apply where there is a difference in risk, as between 
bricks and powder, or coal and crockery; nor where there is 
a difference in trouble, as between live stock and wheat. Any 
difference that can reasonably be explained as due to a dif- 
ference in cost is not discrimination; on the other hand, a 
difference in cost without a difference in rate is discrimina- 
tion. Discrimination as to goods may be by value, as low 
rates for heavy, cheap goods, and high rates for lighter, valu- 
able ones. Coal always goes at a low rate as compared with 



Ch. 28] THE TRANSPORTATION PROBLEM 485 

dry goods, and sometimes more is charged for coal to be used 
for gas than for coal to be used for heating purposes. 

Railroad discrimination so frequently has resulted in in- 
justice to the shipping public that the term has taken on an 
evil significance. But it is well to observe that the word dis- 
crimination is not derived from crimen (crime), but from 
discernere (to discern). There are both reasonable and un- 
reasonable forms of discrimination. In general, discrimina- 
tion as to goods more often appears, under certain conditions 
and made with due regard to the public interest, to be rea- 
sonable; less often to be justified is the form of local dis- 
crimination next to be described; and least often of all to be 
justified is the last-named form of personal discrimination. 

§ 9. Local discrimination. Discrimination between places 
(called also local discrimination) is charging different rates to 
two localities for substantially the same service. This occurs 
when local rates are high and through rates are low; when 
rates at local points are high and at competing points are 
low; when less is charged for shipments consigned to foreign 
ports than for domestic shipments; when more is charged for 
goods going east thafi for goods going west. The causes 
of local discrimination are : first, water competition, second, 
differences in terminal facilities, making some places better 
shipping-points than others; third, competition by other 
railroads, which is concentrated at certain points, only one 
tenth of the stations of the United States being junctions; 
fourth, the influence of powerful individuals or large corpora- 
tions and the personal favoritism shown by railroad officials. 

The effects of local discrimination are to develop some dis- 
tricts and depress others; to stimulate cities and blight vil- 
lages; to destroy established industries; to foster monopolies 
at favored points ; and to sacrifice the future revenues of the 
road by forcing industry to move to the competing points 
to get the low rates. The power of railroad officials arbi- 
trarily to cause rates to rise or fall is usually limited in prac- 
tice by the need of earning as large and as regular an in- 



486 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

come as possible, but even as exercised it has been at times 
as great as that possessed by many political rulers. 

§ 10. Personal discrimination. Discrimination between 
shippers (personal discrimination) is charging one person 
more than another for substantially the same service. This 
most odious of railroad vices, rarely practised openly, is done 
by false billing of weight, by wrong descriptions or false 
classification to reduce the charge below published rate- 
sheets, by carrying some goods free, by issuing passes to some 
and not to all patrons under the same conditions, or by dona- 
tions or rebates after the regular rate has been paid. In 
some cases a subordinate agent shares his commission with 
the shipper, and the transaction does not appear on the books 
of the company. In other cases favored shippers are given 
secret information that the rate is to be changed, so that they 
are enabled to regulate their shipments to secure the lower 
rate. 

One group of reasons for personal discrimination is con- 
nected with the interests of the road. It is to build up new 
business; it is to make competition with rival roads more ef- 
fective by favoring certain agents, as was very commonly 
done in the western grain business; it is to exclude compe- 
tition, as by refusing to make a rate from a connecting line 
or to receive materials for a new railroad which is to be a 
competitor; and it is to satisfy large shippers whose power, 
skill, and persistence make the concession necessary. An- 
other group of reasons has to do with the interests of the cor- 
porate officials. It is to enable them to grant special favors 
to friends; or it is to bjiild up a business in which they are 
interested; or it is to earn a bribe that has been given them. 

The evils of personal discrimination are great. It intro- 
duces uncertainty, fear, and danger into all business; it 
causes business men to waste, socially viewed, an enormous 
fund of energy to get good rates and to guard against sur- 
prises; it grants unearned fortunes and destroys those hon- 
estly made; it gives enormous power and presents strong 



Ch. 28] THE TRANSPORTATION PROBLEM 487 

temptations to railroad officials to injure the interests of the 
stockholders on the one hand and of the public on the other. 

§ 11. Economic power of railroad managers. Other 
evils of unre^lated private management of railroads ap- 
peared. "When the railroad was a young industry, it was 
thought to be simply an iron-track turnpike to which the 
old English law of common carriers would apply. This and 
similar notions soon, however, proved illusory. It was seen 
that the higher railroad officials had, in the granting of trans- 
portation service and the fixing of rates, a great economic 
power. They had complex and sometimes conflicting duties 
to the stockholders and to the shipping public. They wore 
their conscience burdens lightly before the days of effective 
regulation, and frequently made little attempt to meet the 
one and no attempt whatever to meet the other obligation. 
The opportunities for private speculation brought to many 
railroad managers great private fortunes. There were no 
precedents, no ripened public opinion, no established code of 
ethics, to govern. It was a betrayal of the interests of the 
stockholders when directors formed "construction compa- 
nies" and granted contracts to themselves at outrageously 
high prices. It was an injury not only to shippers, but also 
to the stockholders, when special rates were granted to friends 
and to industries in which the directors were interested. In 
general, however, the interests and rights of the stockholders 
were more readily recognized than were those of the public. 
A railroad manager is engaged by the stockholders, is re- 
sponsible to them, and looks to them for his promotion. 
Hence their interests are uppermost whenever the welfare of 
the public is not in harmony with the earning of liberal divi- 
dends. The managers long felt bound to defend the prin- 
ciple of "charging what the traffic will bear" in the case 
of each individual, locality, and kind of goods, even if this 
ruined some men and enriched others, and if it destroyed 
the prosperity of cities to increase the earnings of the road. 

§ 12. Political power of railroad managers. Likewise in 



488 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

various ways railroad managers, unlimited by rate regulations, 
may exercise great political influence and power. Some 
writers maintain that the power to make rates on railroads 
is a power of taxation. They point out that, if rates are not 
subject to fixed rules imposed by the state, the private mana- 
gers of railroads wield the power of the lawmaker. By 
changing the rates on foreign exports or imports, the rail- 
roads frequently have made or nullified tariff rates and have 
defeated the intention of the legislature. On the other hand, 
high rates on state-owned roads in Europe have been used 
in lieu of protective duties. These facts go to show that a 
change of railroad rates between two places within the coun- 
try is similar in effect to the imposing or repeal of tariff 
duties between them. 

The wealth and industrial importance of the railroads soon 
began to give them widespread political power in other ways. 
It was commonly charged in some states that the legislature 
and the courts were "owned" by the railroads. The rail- 
roads, in part because they were the victims at times of at- 
tempts at blackmail by dishonest public officials, declared 
that they were compelled in self-defense to maintain a lobby. 
The railroad lobby, defensive and offensive, was, in many 
states, the all-powerful "third house." Railroads even had 
their agents in the primaries, entered political conventions, 
dictated nominations from the lowest office up to that of 
governor, and elected judges and legislators. The extent to 
which this was done differed according as the railroads had 
large or small interests within the state. These statements 
can with approximate truth now be made in the past tense, 
as was not possible a few years ago. A better code of busi- 
ness morality has developed, and the railroad management's 
relationship of private trusteeship toward the shareholders 
and of public trusteeship toward the patrons of the road is 
now much more fully recognized. The change was not 
brought about, however, without long and strenuous agitation 
and effort, educational and legislative. 



Cii. 28] THE TRANSPORTATION PROBLEM 489 



References. 

Gephart, W. F., The place of the canal in a national svstem of trans- 
portation. A. E. Assn. Bui.. 4th ser., I (no. 2) : '188-19G. 1911. 
Round table discussion, 197-203. 

Hadley. A. T., Railroad transportation. N. Y. Putnam. 1884. 

Johnson, E. R., American railway transportation. 3d ed. N. Y. 
Appleton. 1908. 

Johnson, E. R., Inland waterway policy. A. E. Assn. Bui., 4th ser., 
1: 166-174. 1911. 

Johnson, E. R.. The Panama Canal and commerce. Pp. 295. New 
York. Appleton. 1916. 

Johnson, E. R., and Huebner, G. G., Principles of ocean transporta- 
tion. N. Y. Appleton. 1918. 




490 



CHAPTER 29 



RAILROAD REGULATION 



§ 1. Peculiar privileges of railroads. § 2. Public nature of the 
railroad. § 3. State railroad commissions. § 4. Consolidation and 
need of national regulation. § 5. The Interstate Commerce Act. 
§ 6. The Commission's powers strengthened. § 7. Fixed rates and 
declining net earnings. § 8. Federal control of railroads. § 9. Trans- 
portation Act of 1920. § 10. Significance of the Transportation Act. 

§ 1. Peculiar privileg-es of railroads. The various grants 
of lands and money to the railroads make them other than 
mere private enterprises. Those in control of the railroads 
usually denied this and asserted the right to run "their own 
business" as they liked. They said that the bargain was a 
fair one, and was then closed. The public gave because it 
expected benefit; the corporation fulfilled its agreement by 
building the road. The terms of the charter, as granted, 
determined the rights of the public ; but no new terms could 
later be read into it, even though the public came to see the 
question in a new light. Similar grants, though not so large, 
have been made to other industries. Sugar factories were 
given bounties; iron-forges and woolen mills were favored 
by tariffs; factories have been given, by competing cities, 
land and exemption from taxation ; j^et these enterprises have 
not on that account been treated, thereafter, in any excep- 
tional way. So, it was said, the railroad was still merely a 
private business. 

But the social answer is stronger than this. ' The privileges 
of railroads are greater in amount and more important in 
character than those granted to any ordinary private enter- 
prise. The legislatures recognize constantly the peculiar 

491 



492 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

public functions of the railroads. In other private enter- 
prises investors take all the risk. Legislatures and courts 
recognize the duty of guarding, where possible, the invest- 
ment of capital in railroads. Laws have been passed in sev- 
eral states to protect the railroads against ticket-scalping. 
Whenever the question comes before them, the courts main- 
tain the right of the railroads to earn a fair dividend. Pri- 
vate enterprise has been invited to undertake a public work, 
yet public interests are paramount. The regulation of rail- 
road rates is not a new condition read into railroad fran- 
chises, but is implied in the grant of a franchise to common 
carriers and is involved in the old English law of common 
carriers. 

§ 2. Public nature of the railroad. As a result of a half- 
century of bitter experiences with the results of the private 
property conception of railroads, a growing part of the 
"public" began to have more definite opinions regarding 
the nature of the railroad business. That opinion by 1870 
had begun to run about as follows. Railroads in our country 
are owned by private corporations and are managed by pri- 
vate citizens, not, as in some countries, by public officials. 
They have been built by private enterprise, in the interest 
of the investors, not as a charity or as a public benefaction. 
Railroad-building appears thus at first glance to be a case 
of free competition where public interests are served in the 
following of private interests. But, looked at more closely, 
it may be seen to be in many ways different from the ordi- 
nary competitive business. Competition would make the 
building of railroads a 'matter of bargain with proprietors 
along the line, and an obdurate farmer could compel a long 
detour or could block the whole undertaking. But the pub- 
lic says: a public enterprise is of more importance than the 
interests of a single farmer. By charter or by franchise the 
railroad is granted the power of eminent domain, whereby 
the property of private citizens may be taken from them at 
an appraised valuation. The manufacturer, enjoying no such 



Ch. 29] RAILROAD REGULATION 493 

privilege, can only by ordinary purchase obtain a site ur- 
gently needed for his business. Why may the railway ex- 
ercise the sovereign power of government as against the pri- 
vate property rights of others? Because the railway is pe- 
culiarly "affected with a public interest." The primary ob- 
ject is not to favor the railroads, but to benefit the commu- 
nity. These charters and franchises are granted sparingly in 
most European countries. In this country they have been 
granted recklessly, often in general laws, by states keen in 
their rivalry for railroad extension. When thus great pub- 
lie privileges had been granted without reserve to private 
corporations, it was realized, too late in many cases, that a 
mistake had been made and that an impossible situation had 
been created. 

If an extremely abstract view is taken, there is danger of 
losing sight of the real problem, which is that of harmonizing 
these two interests in thought and in public policy. Yet the 
extreme advocates of the private control of railroads for a long 
time resented indignantly any public interference with rail- 
road rates and with railroad management as an infringement 
of individual liberty. This position often was inconsistently 
taken by those in whose interests free competition had been 
violently set aside at the very outset of railroad construction, 
and for whom governmental interference had made possible 
great fortunes. It has become generally recognized that the 
railroads ought not to be allowed to change from a public to a 
private character, just as it suits their convenience. True, 
they are private enterprises as regards the character of the 
investment, but they are public enterprises as to their priv- 
ileges, functions, and obligations. 

If there w^ere none of these special reasons for the public 
control of railways, there is an all-sufficient general reason 
in the fact that a railroad is always, in some respects and 
to some degree, a monopoly. Therefore, the railroad problem 
may be viewed as but one aspect of the general problem of 
aionopoly. 



494 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

§ 3. State railroad commissions. When it became appar- 
ent that public and private interests in the railroads were 
so divergent, it still was not easy to determine how the pub- 
lic was to be safeguarded. At first some general conditions, 
such as maximum rates, were inserted in the laws and char- 
ters; but these were not adaptable to changing conditions 
and, for lack of administrative agents, could not be enforced. 
Some early efforts at state ownership were disastrous. The 
old law of common carriers gave to individual shippers an 
uncertain redress in the courts for unreasonable rates; but 
the remedy was costly because the aggrieved shipper had to 
employ counsel, to gather evidence, and to risk the penalty 
of failure; it was slow, for, while delay was death to the 
shipper's business, cases hung for months or years in the 
courts; it was ineffectual, for, even when the case was won, 
the shipper was not repaid for all his losses, and the same 
discrimination could be immediately repeated against him 
and other shippers. 

In the older eastern states, attempts to remedy these and 
other evils by creating some kind of a state railroad com- 
mission date back to the fifties of the last century. Massa- 
chusetts developed on the eve of the seventies (1869) a com- 
mission of the advisory or "weak type," which investigated 
and made public the conditions, leaving to public opinion 
the correction of the evils. A number of the western states, 
notably Illinois and Iowa, developed in the seventies com- 
missions of the "strong type," with power to fix rates and 
to enforce their rulings. The commission principle, strongly 
opposed at first by the railroads, was upheld by the courts 
and became established public policy. By 1915 every state 
and the District of Columbia had a state commission. 

As a remedy for railroad evils, however, the state commis- 
sions, strong as well as weak, were disappointing. It is 
true that from the first they did much to make the accounts 
of the railroads intelligibile, something to make the local rates 
reasonable and subject to rule, and much to educate public 



Cii. 29] RAILROAD REGULATION 495 

sentiment. But it was difficult to get commissioners at once 
strong, able, and honest; the public did not know its own 
mind well enough to support the commissions properly; and 
the courts decided that state commissions could regulate only 
the traffic originating and ending within the state. After 
1888 the state commissions more and more directed their 
activities toward the regulation of local utilities. In "Wis- 
consin and in New York in 1907, in New Jersey in 1911, and 
in many other states since, the ** railroad" commissions were 
replaced by "public utilities" or "public service" commis- 
sions, having control not only over the railroads but over 
street-railway, gas, electric-light, telephone, and some other 
corporations. 

§ 4. Consolidation and need of national regulation. Be- 
fore passing to the discussion of the next era of railway 
policy, reference should be made to the steady movement 
toward the consolidation of small railroad units into larger 
systems, for this was affecting greatly the character of the 
railroad problem. The early railroads, many of which were 
built in sections of a few miles in length, began to be united 
with many branches. The New York Central between Al- 
bany and Buffalo was a consolidation, by Commodore Vander- 
bilt, of sixteen short lines. The Pennsylvania system was 
formed, link by link, from scores of small roads. 

Toward this result strong economic forces were working. 
Consolidation has many technical advantages: it saves time, 
reduces the unit cost of administration and of handling 
goods, gives better use of the rolling stock and of the ter- 
minal facilities of the railroads, and insures continuous train 
service. It has the advantages of other large production and 
the possible economies of the trusts. Most important, how- 
ever, from the point of view of the railroads, is the preven- 
tion of competition and the making possible of higher rates 
and larger dividends. The statement that competition is not 
an effective regulator of railroads often is misunderstood to 
mean that it in no way acts on rates. It is true that com- 



496 PUBLIC POLICY TOWAKD PRIVATE INDUSTRY [Pt. V 

petition between roads does not prevent discrimination and 
excessive charges between stations on one line only; but com- 
petition usually has acted powerfully at well-recognized 
''competing points." The larger the area controlled by one 
management, the fewer are the competing points; the larger, 
therefore, is the power over the rate and the more completely 
the monopoly principle applies. It is a grim jest to say that 
consolidation does not change the railroad situation as re- 
gards the question of rates. 

§ 5. The Interstate Commerce Act. We now come to the 
third era of railroad policy, that of a weak and ineffective 
control by a federal agency. Public hostility to private rail- 
road management was greatest in the regions where the most 
rapid building of roads occurred from 1866 to 1873. One 
center of grievances was in the "Granger states" of Illinois, 
Wisconsin, Kansas, Nebraska, Iowa, and Minnesota; another 
center was in the oil regions of Ohio and Pennsylvania, The 
eastern states were not without their troubles, for the report 
of the Hepburn Committee of the New York legislature in 
1879 showed that discrimination between shippers prevailed 
to an almost incredible degree in every portion of New York 
state. When the courts, in 1886, decided that the greater 
portion of the railroad rates could not be treated by state 
commissions, national control was loudly demanded. Scores of 
bills were presented to Congress between 1870 and 1886, 
and, despite much opposition, the act creating the Interstate 
Commerce Commission was passed in 1887. 

The act laid down some general rules: that rates should 
be just and reasonable; that railroads should not pool, or 
agree to divide, their earnings to avoid competition; that 
they should under similar conditions, and unless expressly 
excused, fix rates in accordance with the long- and short-haul 
principle (to charge no more for a shorter distance than for 
a longer one on the same line and in the same direction, the 
shorter being included within the longer). The act pro- 
vided for a commission of five men, to be appointed by the 



Cn. 29] RAILROAD REGULATION 497 

President, which might require uniform accounts from the 
railroads and which should enforce the provisions of the act. 
The commission in its earlier years gave promise of effective- 
ness, but its powers, as narrowly interpreted by the courts, 
proved inadequate to its assigned task. Court decisions 
paralyzed its activity, and the railroads in many cases re- 
fused to obey its orders. Competent authorities declared in 
1901, after fourteen years of the Commission's operation, that 
discrimination never had been worse, and a series of exposures 
of abuses strengthened the popular demand for stricter legis- 
lation. Weak federal regulation had been valuable as a means 
of educating public opinion, but had failed as a means 
of remedying railroad evils. 

§ 6. The commission's powers strengthened. The latest 
era, that of strong federal regulation, preluded by the pas- 
sage of the Elkins Act in 1903, aimed at discrimination and 
rebates, began definitely with the Hepburn Act of 1906. 
The Commission was increased to seven members, its authority 
was extended to include express, sleeping-car, and other 
agencies of transportation, and it was given the power to fix 
maximum rates, not to be suspended by the courts without 
a hearing. It became thus unquestionably a commission of 
the "strong type." It began to exercise its new poAvers with 
vigor, and the carriers reluctantly accepted its authority, as 
an evil less than that of "forty-nine masters." Responsive 
to a calmer but insistent popular demand, further amendments 
were made by the IMann-Elkins Act of 1910, which stren^h- 
ended the long- and short-haul clause, and gave to the Com- 
mission, among other new powers, that of suspending new 
rates proposed by carriers. A special Commerce Court of 
five judges was created with exclusive jurisdiction in certain 
classes of railroad cases, but this was abolished after a short 
trial. 

Now began by the Commission an exercise of effective 
power. Complaints and prosecutions constantly brought to 
light many graver violations and many hidden abuses and 



498 



PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 



minor violations of the act. Though an ideal condition 
might never be attained, the evils of favoritism by public 
carriers seemed in the way to be ended. The Commission, 
having absolute control over rates, kept them down. Accord- 
ing to public opinion, this was the Commission's chief duty. 



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Fig. 2, Chapter 29. — Decline of railroad rates, relative to prices and 
railway wages, 1905-1920. 

Note: The main reason for the growing financial difficulties of the 
railroads, especially after 1915, is evident here. The increases in rates 
were tardy, and inadequate to keep pace with rising costs. The last 
large rate increase, effective in September 1920, occurred several 
months after wholesale prices had passed their peak and were rapidly 
falling, and traffic was declining. 

§ 7. Fixed rates and declining: net earnings. At this 
point a new feature appeared in the situation. The curve 
of general prices continued, with slight irregularities, to rise 
after 1897, and railroad wages had been about keeping pace, 
moving now a little behind and then ahead, as a result of 
concessions, of strikes, of threatened strikes, and of decisions 



Ch. 29] 



RAILROAD REGULATION 



499 



in arbitration. Thus almost everything that railroads had 
to buy — repairs, equipment, materials, labor of all kinds, 
had been increasing, while the average of freight rates was 
somewhat decreasing.^ The result was decreasing railway 
net earnings, falling railway credit, rapid slackening of rail- 
way-building, and inadequate maintenance of existing equip- 
ment. Railroad facilities and capacity, despite substantial 
technical progress in some respects (size of engines, train 
loads, etc.), was not keeping pace with the growth of the 
population and of the business of the nation. 

By 1914 the danger of 
this course began to be ap- 
parent to the public mind. 
The application of the roads 
for permission to raise va- 
rious rates (in what was 
called, somewhat inaccu- 
rately, the "5 per cent 
case") was still opposed by 
the irreconcilable opponents 
of the roads. Many state 
railroad commissions united 
to oppose the granting of the 
application, and Mr. Louis 
Note : The heavy line is a smoothed D. Brandeis, as special 
curve, showing the general trend counsel for the Commission, 

of net earnings of a representative „^ i • i -n- . i • r. 

..,'=, ^ , , urged in a brilliant brief, 

group of railroads; a general down- , 7,, , . 

ward trend appears, only partially ^^^^ sophistical, half SOund, 
oflFbet by successive rate increases, that all of the additional 

revenues needed could and 
should be obtained by further economies in railroad manage- 
ment. In July, 1914, the Commission granted a part of the 
railroads' plea, the dissent of two members being on the 
ground that all was needed and should be granted. The Com- 
mission then by successive orders came over by the foUow- 
1 See Figure 2. 




Fig. 3, Chapter 29.— Decline of 
railroad net earnings, 1916-1921. 



500 PUBLIC POLICY TOWARD PPvIVATE INDUSTRY [Pt. V 

ing December to the view of the minority, and granted further 
increases. Even this relief proved to be quite inadequate, 
as prices rose in 1915, making railway rates, relative to the 
monetary values of the goods transported, less than ever be- 
fore. But in principle and as a precedent, this action of the 
Commission was important, for it reflected a change of public 
opinion. A good part of the public had begun to glimpse the 
truth that it is the duty of a public authority with absolute 
rate-fixing power to fix rates high enough as well as to keep 
them low enough; and they are not high enough if they do 
not give a return sufficient to maintain the existing plant and 
to attract new investments. 

§ 8. Federal control of railroads. Railway net earnings 
moved up ^ and down in 1916, helped by the great growth 
of tonnage and hurt by further rise of prices and wages. 
Then came our entry into the war in April, 1917. At once 
the railroads united voluntarily in creating a Railroad War 
Board, seeking to put every facility of the railroads at the 
disposal of the government. The rolling stock and trackage, 
however, were quite inadequate to carry the war traffic, and, 
with a view to their more efficient use in the war, they were 
federalized by presidential proclamation in December, 1917 
(under powers granted by an anticipatory law of August, 
1916). The conditions and details were fixed by the Railroad 
Control Act of March, 1918. By this the roads were guaran- 
teed while under government control net revenues based 
on the earnings of the three-year test period ending the pre- 
ceding June. The roads iwere to be returned, not less than 
twenty-one months after the conclusion of peace, in as good 
condition as they were when taken. In every way possible, 
priority of shipment was given to materials for army and navy 
and to goods that had a more or less visible relation to the 
winning of the war. At the head of the federal "Railroad 
Administration" was the Secretary of the Treasury, who 
was clothed with well-nigh unlimited war-time powers, and 

2 See Figure 3. 



Cn. 20] RAILROAD REGULATION 601 

in fact became the president of the consolidated railroads of 
America. "Whenever he and his advisors felt it to be to 
the public interest, the division lines of private ownership 
were obliterated in a manner that was revolutionary in rail- 
road practice. Palatial passenger terminals built b}' the 
enterprise of single companies were thrown open to the use 
of competing lines, equipment was interchanged, superfluous 

Railroad Wages & Living Costs 
Compared with 1917 



1918 



1919 



1920 



^ ■^■■■■■^■■IHHi 41.3% 
Increase Yearly Wages 

Increase Cost of Livint: 
Increase Yearly Wages 

i w^v ' yyy.-^ 39.9 % 

\ Increase Cost ol Living 

^■■^■■■■■■i^HHHH^HHHiiHHHHHi79.8 
Increase Yearly Wages 

I40.7Z 



Increase Cost of Living 
NOTE: Cost of Living highest in June 1920-52';^ above Dec.l9l7. 
Feb.1,1921 it was 11.4% lower than in June 1920. 
according to the U.S. R.R. Labor Board 

Fig. 4, Chapter 29. — Railroad wages compared with living costs, 1917 
and succeeding years. 

Note: Wages are average for each year, cost of living is of date 
December of each year. After the slump in prices in 1920, railroad 
wages remained relatively much higher than railroad rates and net 
earnings. These figures were presented by the railroads in their plea 
to the public for a lowering of wages, to show that railroad labor had 
virtually "profiteered" in the war conditions. In some details the 
spokesmen of the railroads question these figures, although the gen- 
eral trend is unquestioned. 

competing trains between large cities were discontinued, to 
the astonishment of those who cherished the old competitive 
conception of railroad operation. Despite heroic efforts, rail- 
road operation at times nearly broke down, freight terminals 
were blocked for miles, and side-tracks were filled with loaded 
cars that could not be moved. In these conditions and with 
general prices and railroad wages rising, the net earnings 



502 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

fell short of the guaranties. In May, 1918, rates both for 
passengers and for freight were sharply advanced, freights 
by a flat 25 per cent, besides many other advances and re- 
classifications. This gave immediate relief, which helped to 
carry the railroads through to the end of federal control; 
but rising prices and wages again overtook the railroad 
receipts. 

§ 9. Transportation Act of 1920. After the armistice, the 
return of the railroads to private control became the subject 
of much discussion in financial and in political circles. 
Though railroad finances fared better after the increase 
of rates in May, 1918, net earnings fell again in the tem- 
porary business recession early in 1919, to rise again in the 
business boom of mid-1919 ; then, as a result of the continued 
rise of costs and wages, fell again nearly to zero by mid-1920. 
The Interstate Commerce Commission then granted a large 
increase of rates, both passenger and freight, effective in Sep- 
tember, 1920. Meantime in February the "Transportation Act 
of 1920, ' ' otherwise known as the Bsch-Cummins Act, became 
law, returning the railroads to their owners March 1, 1920. 
This law necessarily postponed the task of "unscrambling" 
the railroad omelet and settling the government's indebted- 
ness to the several roads. But, more important for the 
future, amendment of the Interstate Commerce Act increased 
its membership to eleven, and in various ways implied a 
new, or advanced, view of the railroad problem. The chief 
new features are : ^ 

1. Rates must be adequate to yield a fair return on the 
aggregate value of the property of the carriers, either in the 
entire country or in rate groups. This is assumed to be the 
first two years 5i/^ per cent (but may be 1/2 Per cent more 
to make provision for improvements) on the valuation to be 
fixed by the Commission. 

2. Net earnings of any carrier are to be limited to 6 per 

3 The labor adjustment features of the law have already been indi- 
cated in eh. 22. 



Ch. 29] RAILROAD REfiULATION 508 

cent and one half of the excess, the other half to be paid to 
the Commission for a contingent fund to be lent to weaker 
roads or used in other ways helpful to the railway conditions. 

3. All the railroads are to be consolidated into a limited 
number of systems by a plan to be prepared by the Commis- 
sion, but this plan as yet is only to be recommended, not en- 
forced upon the carriers. Within each system, consolidation, 
mergers, division of traffic, and pooling may be authorized by 
the Commission. 

4. Joint use of terminals may be required by the Commis- 
sion. 

5. Stricter control is to be exercised over railroad policies, 
including security issues, routing of traffic, car service, dis- 
crimination, and other features. 

§ 10. Significance of the Transportation Act. This act 
was almost unanimously conceded, by those of divergent views, 
to contain many commendable features, and is generally char- 
acterized as the last trial of private ownership as well by 
those who favor as by those who would deplore such an out- 
come. It brings to an end the regime of private railway 
ownership and management in the United States, in which 
private interests were uppermost for good and for evil. In 
that period constructive minds have built great railroad 
systems and have developed marvelously the technic of rail- 
road management; but great financial interests have made 
the railroads the pawns with which they played a game for 
private riches and personal power. The most important 
question to be answered is this : how is it going to be possible 
to preserve the vitalizing force of competition in railroad 
transportation when competition between carriers has been 
ended ? 

The question is paradoxical, but it admits of a valid 
answer, if the American public has wisdom and political 
virtue enough to apply it. That answer is: keep politics out 
of railroad management; preserve and intensify the motives 
of personal ambition everywhere among the officers and em- 



504 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

ployees of railroads; let merit, not favoritism, determine 
appointments; let railroad service in all its branches be a 
technical career in which one who succeeds in any position, 
on any road, in any part of the country, may hope for recog- 
nition and worthy reward anywhere else where there is a 
bigger job to fill. Railroads as such can no longer compete in 
rates; it is a question whether they may even continue to 
compete in service, for that too must tend to become stand- 
ardized, as well in quality as in price. But only in a figura- 
tive sense did railroads ever compete. Railroads are imper- 
sonal things; only men compete, only men can have motives 
that are an essential part of the idea of competition. Under 
a wise public policy, men ought to continue to compete in rail- 
road work and management; indeed, they might do it more 
effectively than under the regime of personal and corpora- 
tion favoritism and of frenzied finance that made such monu- 
mental failures of many of the railroads under unregulated 
private management in the past. 

Refeeences. 

Adams, H. C, American railway accounting. A commentary. Pp. 
465. New York Sta.te. 1918. By the director of the accounting 
and statistical work of the I. C. C. from 1887 to 1911. 

Brovm, E. G., Transportation rates and their regulation. N. Y. 
Macmillan. 1916. 

Johnson, E. R., and Van Metre, T. W., Principles of railroad trans- 
portation. Pp. 619. N. Y. Appleton. 1916L 

McFall, B. J., Railway monopoly and rate regulation. N. Y. Long- 
mans. 1916. 

Materials for the study of elementary economics by L. P. Marshall 
and others. Pp. 627, 628. Univ. of Chic. Press. 1913. 

Ripley, W. Z., (Ed.), Railway problems. Bost. Ginn. 1907. 

Ripley, W. Z., Railroads,: rates and regulations. N. Y. Longmans. 
1912. 



CHAPTER 30 
THE PROBLEM OF INDUSTRIAL MONOPOLY 



§ 1. Kinds of monopoly. § 2. Political sources of monopoly. § 3. 
Natural and capitalistic monopolies. § 4. Monopoly and corporate 
organization. § 5. Rise of the corporation concept. § 6. Advantages 
of corporate organization. § 7. Growth of large industry in the nine- 
teenth century. § 8. Trusts and combinations. § 9. Methods of form- 
ing combinations. § 10. Growth of combinations after 1880. § 11. 
The great period of trust formation. § 12. Height of the movement 
toward combinations. § 13. Motive to avoid competition. § 14. Mo- 
tive to effect economies. § 15. Profits from monopoly and gains of 
promoters. § 16. Monopoly's power to raise prices. 

§ 1. Kinds of monopoly. The problem of monopoly is 
probably as old as markets. From the first coming together of 
groups of men to trade, there were doubtless efforts made by 
some individuals and groups of traders to manipulate condi- 
tions so as to get higher prices than they could get in a free 
and open market.^ There are traces of the practices in 
ancient times, and the history of the Middle Ages is full of 
evidences both of monopolistic practices and of the efforts to 
prevent or control them. ^Monopoly may be defined as such 
a degree of control over the supply of goods in a given market 
that a net gain will result if a portion is withheld. 

Monopolies may, for special purposes, be classified as 
selling or buying, producing or trading, lasting or temporary, 

1 See Vol. I, ch. 8, on competition and monopoly', and ch. 31 on mo- 
nopoly prices and large production. An understanding of the defini- 
tions and of the general principles distinguishing competition and mo- 
nopoly is necessary to a profitable discussion of the practical problem 
of monopoly. 

505 



506 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

general or local, monopolies.^ The term monopoly applied 
by its etymology ^ only to selling, but by usage also to buying. 
Under conditions of barter the selling and the buying monop- 
olies would be the same things in two aspects. A selling 
monopoly is by far the more common, but a buying monopoly 
may be connected with it. A large oil-refining corporation 
that sells most of the product may by various methods 
succeed in driving out the competitors who would buy the 
crude oil. It thus becomes practically the only outlet for the 
oil product, and the owners of the land thus must share their 
ownership with the buying monopoly by accepting, within 
certain limits, the price it fixes. The Hudson's Bay Com- 
pany, dealing in furs, had virtually this sort of power in 
North America. Many instances can be found ; yet, relatively 
to the selling monopolies, those of the buying kind are rare. 

A producing monopoly is one controlling the manufacture 
or the source of supply of an article; a trading monopoly is 
one controlling the avenues of commerce between the source 
and the consumers. 

Monopolies are lasting or temporary, according to the dura- 
tion of control. By far the larger number are of the tem- 
porary sort, because high prices strongly stimulate efforts to 
develop other sources of supply. Yet the average profits of 
a monopoly may be large throughout a succession of peri- 
ods of high and low prices. 

Monopolies are general or local, according to the extent of 
territory where their power is felt. At its maximum, where 
transportation and other costs most effectually shut out com- 
petition, monopoly power shades off to zero on the border- 
line of competitive territory. The frequent use of the ad- 
jectives partial, limited, and virtual are implied but usually 
superfluous recognitions of the relative character of monopoly. 

2 For definitions and discussions of monopoly as economic power 
and as an enterprise in which power is exercised, the reader should 
carefully consult the various references in the index of Vol. I. 

3 See Vol. I, p. 76. 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 507 

§ 2. Political sources of monopoly. Monopoly gets its 
power from various sources. A political monopoly derives 
its power of control from a special grant from the govern- 
ment, forbidding others to engage in that business. The typ- 
ical political monopoly is that conferred by a crown patent 
bestowing the exclusive right to carry on a certain business. 
A second kind is that conferred by a patent for invention, or 
a copyright on books, the object of which is to stimulate in- 
vention, research, and writing by giving the full control and 
protection of the government to the inventor and the writer 
or their assignees. In this case the privilege is socially 
earned by the monopolist ; it is not obtained for nothing. 
Moreover, the patent, being limited in time, expires and be- 
comes a social possession. A third kind is a governmental 
monopoly for purposes of revenue. In France and Japan the 
governments control the tobacco trade, and the high price 
charged for tobacco makes this monopoly yield large revenues. 
A fourth kind is that derived from franchises for public serv- 
ice corporations, such as those supplying electricity, gas, and 
water. These franchises are granted to private capitalists to 
induce them to invest capital in enterprises that are helpful 
to the community. 

§ 3. Natural and capitalistic monopolies. Monopoly has 
been called economic or natural when it rests on the owner- 
ship of scarce natural agents, as mines, land, water-power, 
under the control of one man or one group of men who agree 
on a price. Economic monopoly is a result of private prop- 
erty that is undesigned by the government or by society. It 
is exceptional considering the whole range of private prop- 
erty, but it is important. The oil-wells embracing the main 
sources of the world's supply have largely come under one 
control. One corporation may control so many of the rich- 
est iron-mines of the country as to be able to fix a price dif- 
ferent from that which would result under competition. 
Coal-mines, especially those of some peculiar and limited kind, 
such as anthracite, appear to become easily an object of monop- 



508 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Ft. V 

olization. Economic monopoly merges into political monopo- 
lies, such as patents and franchises. Private property is a 
political institution designed to increase social welfare, and 
only rarely is property in any particular business a monopoly. 
Private control of any great natural resources might have 
been prevented in many cases had it been foreseen. 

Monopoly is called capitalistic, or contractual, or organ- 
ized, or commercial, or industrial, when it arises from the 
power under one control to dominate the market, to intimi- 
date opposition, and to keep out or limit competition by the 
mere magnitude of wealth. These various kinds so merge 
into one another that they cannot always be distinguished in 
practice. A patent may help a capitalistic monopoly in get- 
ting control of a market ; great wealth may enable a company 
to get control of rare natural resources. 

§ 4. Monopoly and corporate organization. It is nec- 
essary to distinguish from monopoly three other features 
appearing in some enterprises, that are readily and constantly 
confused with monopoly, viz. : large individual capital, large 
production, and corporate organization.* Evidently any one 
of these four features may appear without the other; e. g., a 
person of large aggregate capital may have his investments 
distributed among a large number of small enterprises, such 
as farms, without a trace of corporate organization or monop- 
oly, and numerous examples could be given of large produc- 
tion, or of corporate organization, or of monopoly, without one 
or more of the other features. 

But the presence of any one of these features is a favoring 
condition for the development of the others. Hence they are 
frequently found together, and of late this occurs increasingly. 
It is diffcult to say in every, indeed in any, case which feature 
has been cause and which effect in this development ; but, on 
the whole, large production seems to have been primary. It- 

4 See Vol. I, p. 267, on capital; pp. 388-393, on large production. 
See also references in preceding note 1 on monopoly. 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 509 

self made possible by inventions, by better transportation, and 
by the widening of markets, it in turn helped to build up large 
individual fortunes, and then to create a need for the corpo- 
rate form of organization. And monopoly power no doubt is 
more easily gained bj- large aggregations of capital in a cor- 
poration having the advantages of large production. 

In the frequent concurrence of these four features in a mod- 
ern industry, probably the dominant role is taken by corpo- 
rate organization. It has been, often in a special sense, causal 
in that it has made possible and advantageous great aggrega- 
tions of capital and large units of production, and thus has 
bestowed monopolistic power. 

§ 5. Rise of the corporation concept. In the legal sys- 
tems of primitive people and long afterwards, only natural 
persons had legal rights, could make contracts, have property, 
and carry on a business. But in a number of cases, very 
early, gi'oups of men came to have certain interests in common 
and certain possessions. Gradually some such groups gained 
more or less of legal recognition, with certain political and 
economic rights as a body and not as individuals. Thus 
evolved the conception of a "corporation" (body) having men 
as "members," an artificial person, yet not the same as any 
one or as all the individuals together, and legally distinct from 
the individuals. A group of burghers obtaining a charter 
from the lord of the realm became a municipal corporation ; a 
group of teachers, a collegium, became the corporation of 
a college or a university (a number of persons united into one 
association) ; a group of craftsmen became a gild corporation. 
Each corporation had certain rights, privileges, and immuni- 
ties, and used a corporate seal as a signature. All of the 
early corporations had some economic features that were inci- 
dental to the main purposes, which were political, ecclesias- 
tical, educational and fraternal. Toward the end of the 
jMiddle Ages groups of traders obtained charters to act as 
corporations permanently for business purposes, such as for- 
eign trade, colonization, and banking. These increased in the 



510 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

sixteenth and seventeenth centuries, and in the eighteenth 
century this form of organization was adopted also, and 
parliamentary charters obtained, by groups of men for 
building turnpikes and canals and for carrying on other kinds 
of business. The great era of the corporations did not begin, 
however, until well on in the second quarter of the nineteenth 
century. Then, both in Europe and in America, the corpo- 
rate form of organization was extended to a greater number 
and to other kinds of enterprises. 

§ 6. Advantag'es of corporate organization. The cor- 
porate form proved itself to be well adapted to enterprises 
for the construction and operation of canals and railroads, 
requiring a larger amount of capital than usually could or 
would be risked by one person. The investor in a corporation 
bought shares, and his liability for debts and losses was lim- 
ited by charter to his share capital. It is an advantage that 
permanent enterprises of that kind are owned by corpora- 
tions with charters perpetual or for long periods. It is pos- 
sible for corporations to make investments running for longer 
periods than would be safe for individuals. The corporation 
with an unlimited charter has legally an immortal life. 
Sale and change of management are not necessary on the 
death or failure in health of any one owner. As the factory 
system, and large production developed, the corporate form 
of organization was found to have these same advantages in 
manufacturing. It appeared in textile, iron, mercantile, and 
other industries. After 1865 the corporate form of organiza- 
tion increased at a cumulative rate, until now it is applied to 
many enterprises of small extent and local in operation. 
Of the 300,000 corporations making returns to the United 
States Commissioner of Internal Revenue in 1915, 70,000 were 
manufacturing corporations, which were 26 per cent of the 
whole number of manufacturing establishments, but which 
employed 76 per cent of all wage-earners and turned out 7.9 
per cent of the whole product. 

With the corporations came the ''corporation problem,'* a 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY .111 

single name for a complex of problems — legal, political, moral, 
and economic — which arise out of the relations of corporations 
to their individual stockholders, to their employees, to the 
state, to the general public, and to their competitors in busi- 
ness. The problems differ also in corporations of different 
sizes and in different businesses. Of the various forms of cor- 
porations, banks first presented problems calling for eco- 
nomic legislation and regulation. This is explained by the 
fact that it was the first kind of business corporation to be- 
come important, and further by the fact that its work was 
in various ways closely connected with coinage and regulation 
of money, which had already become a governmental function. 
The railroad was the form of corporation next, in point of 
time, to become a great problem — this because of the pecul- 
iarly vital and far-reaching effects that such railroad trans- 
portation has upon all other kinds of business in the com- 
munity. Finally, industrial monopoly loomed before the 
American people threatening the very existence of our demo- 
cratic society. 

§ 7. Growth of large industry in the nineteenth century. 
The great recent growth of the monopoly problem is in part 
to be explained as the result of the growth of large industry 
as a favoring condition. Before the middle of the last cen- 
tury a tool-using household industry, on farms and in homes 
where the greater part of the things used were produced 
in the family, was still the typical organization in the United 
States.^ A family produced somewhat more than it needed 
of food and cloth, r.il exchanged with its neighbors; so 
with shoes, candles, soap, and cured meats. The early 
factories growing out of the household industry were small. 
Since that time two counter-forces have been at work to 
affect the ratio of manufacturing establishments to popu- 
lation. The number of small establishments has been in- 
creased by the many industries producing the things once 
made on farms, and by increasing demands for comforts 

5 See ch. 27, § 3; and cb. 26, § 7 and § 8. 



512 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

and luxuries. Many establishments producing the staple 
products that can be transported have been consolidated 
or have been enlarged, so that the unit of production 
now averages much larger. The number of cotton-weaving 
factories was about the same in 1900 as it had been seventy 
years earlier, while population had grown sixfold. Iron- and 
steel-mills were fewer in 1900 than in 1880. In industries 
having local markets or local sources of materials, such as 
grist-mills and saw-mills, the change in numbers was less, 
for many small establishments were started in outlying dis- 
tricts at the same time that the mills became larger in the 
great population centers. But the average number of em- 
ployees and the average capital per establishment increased 
in every period between census enumerations. 

§ 8. Trusts and combinations. In the discussion of 
monopoly, misunderstanding has resulted from lack of definite- 
ness in the use of words, which have rapidly shifted in mean- 
ing. The word trust was originally applied, and still in legal 
usage applies, to a particular form of organization, that of 
a board of trustees holding the stock, and thus unifying the 
control, of two or more formerly separate enterprises. The 
Standard Oil Company at one time had this form of organiza- 
tion, which was declared by the courts to be illegal {ultra 
vires) for corporations. Now trust often is used in the 
sense of a corporation having monopoly power in some degree : 
either broadly, of any monopolistic corporation (including 
railways and local public utilities), or, oftener, limited to 
manufacturing and commercial monopolies, otherwise called 
' ' industrial trusts, ' ' in contrast with franchise trusts and rail- 
roads.® The word combination referred originally to a more 
or less thorough ''merger," with a view to attaining monop- 
olistic power, of a number of formerly separate organizations, 
as in the case of the United States Steel Corporation. But 
the word is often used as if it were a synonym for trust (in 

6 As in the list in § 10 and § 11, below. 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 513 

a narrower or wider sense) even as applied to a single enter- 
prise that has grown to be monopolistic. A ''trust" in the 
legal sense of a form of organization, and "combinations" 
as above defined, might have no monopoly power whatever; 
whereas a monopoly may be possessed by an individual owner 
(e. g.. of a patent right, railroad, or water-works plant) or 
by a single corporation that has simply grown monopolistic 
without the trust form of organization or without combina- 
tion. 

The chief problem is monopoly, however attained. In 
accord with growing and now dominant usage, it is well to 
observe the following meanings in our discussion. Combina- 
tion is a term referring particularly to one method by which 
monopolies are formed. Trust, in the now popular sense, 
is best limited to an industrial, primarily manufacturing, en- 
terprise or group of enterprises, with some degree of monop- 
oly power due to a group of favoring technical,- financial, 
and economic conditions. The trust may consist of a single 
establishment; or of a group of establishments separately 
operated, but united in a " pool ' ' to divide output, territory, 
or earnings; or of such a group held together by a holding 
company or combined into one corporation. Puhlic utility is 
the name of an enterprise having a "special franchise" giv- 
ing the use of streets and highways and the right of eminent 
domain, and includes, in the broad sense, railroads and local 
utiMties, such as street railways, gas, water, and electric- 
light plants. 

§ 9. Methods of forming combinations. Combinations of 
previously independent enterprises may be more or less com- 
plete and are made by different methods. Four major meth- 
ods are: 

(1) The pool, by which the enterprises continue to be sepa- 
rately operated, but divide the traffic (or output), or the 
earnings, or the territory, in prearranged proportions. 

(2) The trust, in a legal sense (as defined in §8). 



514 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

(3) The holding company, a corporation with the sole pur- 
pose of holding the shares of stock, or a controlling number 
of them, in various corporations otherwise nominally inde- 
pendent, 

(4) Consolidation into one company. 

At least five minor methods may be distinguished; these 
are here numbered continuously with the preceding four : 

(5) Lease by one company of the plants of one or more 
other companies. 

(6) Ownership of stock by one corporation in another cor- 
poration, sufficient to give substantial influence over its pol- 
icy, if not absolute control. 

(7) Ownership of stock, by the same individual or group of 
individuals, in two or more competing companies, to such 
an extent as appreciably to unify the policies of the compet- 
ing companies. 

(8) Interlocking directorates, that is, boards of competing 
companies containing one or more of the same persons as 
directors. 

(9) Gentlemen's agreements, mere friendly informal con- 
ferences and understandings as to common policies. 

§ 10. Growth of combinations after 1880. Undoubtedly, 
industry before 1860 had some elements of monopoly. Mo- 
nopoly constituted part of the banking problem; it began to 
be evident in the railroads almost at once, and it rapidly in- 
creased as street railways and other public utilities were con- 
structed. But after 1880 occurred the formation in larger 
numbers of industrial enterprises which appeared to exercise 
some monopoly power. In the years between 1890 and 1900 
this movement was still more rapid. Consolidation took 
place on a great scale in railroads and in manufactures. 
Much of this has been of such a kind that it does not appear 
at all in the figures showing the number of establishments and 
of employees. In the ' data regarding this movement given 
by different authorities many discrepancies appear, as there 
is no generally accepted rule by which to determine the selec- 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 515 

tion of the companies to be included in the lists. One finan- 
cial authority gave the following figures ' regarding the in- 
dustrial companies reorganized into larger units in the United 
States between 1860 and 1899, not including combinations in 
such businesses as banking, shipping, and railroad transporta- 
tion. Some of the enterprises here included have much and 
others probably have little or no monopolistic power. 

Decade Number Organized Total Nominal Capital 

1860-69 2 $ 13,000,000 

1870-79 4 135,000.000 

1880-89 18 288,000,000 

1890-99 157 3,150,000,000 

Total, 40 years 181 $3,586,000,000 

§ 11. The great period of trust formation. The number 
of trusts organized and the capital represented by this move- 
ment in the last of these decades were seven times as great as 
in the thirty years preceding. The figures by years for the 
decade 1890-1899 are as follows: 

Decade Number Organized Total Nominal Capital 

1890 6 $82,000,000 

1891 13 168,000,000 

1892 13 140,000,000 

1893 5 226,000,000 

1894 2 35,000,000 

1895 7 104,000,000 

1896 3 40,000,000 

1897 6 93,000,000 

1898 22 574,000,000 

1899 80 1,688,000,000 

Total, 10 years 157 $3,150,000,000 

The influence of great prosperity shows in the large number 
of combinations ; but in 1893 the number was less, although the 
total nominal capital (stocks and bonds) was still the greatest 
it had ever been in any year. Then came the period of de- 
pression, 1894-97, when both the numbers and the capital 
were comparatively small. Then. from 1898 to 1901 followed 

~ Compiled from data given by the "Journal of Commerce and Com- 
mercial Bulletin," reprinted in the "Commercial Year Book," Vol. V, 
1900, pp. 564-569. 



516 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

the period of the greatest formation of trusts the world has 
ever seen. 

The list of these four years contains the names of the most 
widely known American combinations, a few of which are here 
given with the years of their formation: 1898, American 
Thread, National Biscuit; 1899, Amalgamated Copper, Amer- 
ican Woolen, Royal Baking Powder, Standard Oil of New 
Jersey, American Hide and Leather, United Shoe Machinery, 
American Window Glass; 1900, Crucible Steel, American 
Bridge; 1901, United States Steel Corporation, Consolidated 
Tobacco, Eastman Kodak, American Locomotive. 

§ 12. Height of the movement toward combinations. In 
a list by another authority ^ it appears that the data for all 
industrial trusts are in round numbers as follows : 

Tsl umber of Plants Ac- 
Date 'Number quired or Controlled Total Nominal Capital 
Jan. 1, 1904 318 5288 $7,246,000,000 

These figures, compared with those given above, would 
indicate that the industrial trusts had about doubled in 
the years 1900-1903 inclusive. Probably most of this 
growth was in the years 1900 and 1901; then the move- 
ment became very slow because, as is generally believed, of 
the aroused public opinion, of more vigorous prosecution by 
the government, and of additional legislation against trusts. 
The authority last cited gives in a more comprehensive list, 
in six groups, all the monopolistic combinations in the United 
States, at the date of January 1, 1904, as follows (the figures 
just given above being the totals of the first three groups) :, 

No. of Plants Ac- Total 

Groups Number quired or Controlled Nominal Capital 

1. Greater industrial 

trusts 7 1528 $2,260,000,000 

2. Lesser industrial 

trusts 298 3426 4,055,000,000 

8 John Moody, "The Truth About the Trusts," 1904 



Cii. 30] THE PEOBLEM OF INDUSTRIAL MONOPOLY 517 

No. of Plants A c- Total 

Groups Number quired or Controlled Nominal Capital 

3. Other industrial 

trusts in process 

of reorganization 

or readjustment 13 334 528,000,000 

4. Franchise trusts 111 1336 3,735,000,000 

5. Great steam rail- 

road groups 6 . 790 9,017,000,000 

6. Allied independent 

railroad groups 10 250 380,000,000 

Total, 445 a 7664 a $20,000,000,000 

» In round numbers. 

§ 13. Motive to avoid competition. This remarkable 
movement toward the formation of united corporations from 
formerly independent enterprises called forth a variety of 
explanations. The organizers of trusts gave as the first ex- 
planation of their action that it was the necessary result of 
excessive competition. It is not to be denied that a hard 
fight and lower prices often preceded the formation of the 
trusts. But, as this excessive competition usually is begun for 
the very purpose of forcing others into a combination, this 
explanation is a begging of the question. It is fallacious also 
in that it ignores the marginal principle in the problem of 
profits. Profits are never the same in all factories, and to 
those manufacturers that are on the margin competition may 
appear excessive. It generally has been the largest and 
strongest factories, in the more favored situations, that, in 
order to get rid of troublesome competitors, have forced the 
smaller, weaker industries to come into a trust. In other 
cases the smaller enterprises have been eager to be taken in 
at a good price, although they might have continued to operate 
independently with moderate profits. When, therefore, it is 
said that competition is destructive, it may be a partial truth, 
but more likely it is a pleasantry reflecting the happy humor 
of the prosperous promoters of the combination. 

§ 14. Motive to effect econoipies. Another advantage of 
the combination of competing plants that was strongly em- 



518 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

phasized was the economy of large production.® The econo- 
mies that are possible within a single factory may be still 
greater in a number of combined or federated industries. The 
cost of management, amount of stock carried, advertising, cost 
of selling the product, may all be smaller per unit of prod- 
uct. Each independent factory must send its drummers into 
every part of the country to seek business. In combination 
they can divide the territory, visit every merchant, and get 
larger orders at smaller cost. A large aggregation can con- 
trol credit better and escape losses from bad debts. By regu- 
lating and equalizing the output in the different localities, it 
can run more nearly full time. Being acquainted with the 
entire situation, it can reduce the friction. A combination 
has advantages in shipment. It can have a clearing-house for 
orders, and ship from the nearest source of supply. The 
least efficient factories can be first closed when demand falls 
off. Factories can be specialized to produce that for which 
each is best fitted. The magnitude of the industry and 
its presence in different localities often, in the period of 
trust formation, served to strengthen its influence with the 
railroads, and to increase its political as well as its economic 
power. 

Another phase of corporate growth is the "integration of 
industry, ' ' that is, the grouping under one control of a whole 
series of industries. One company may carry the iron ore 
through all the processes from the mine to the finished prod- 
uct. A railroad line across the continent owns its own steam- 
ers for shipping goods to Asia or Europe. Large wholesale 
houses own or control tlie output of entire factories. 

§ 15. Profits from monopoly and gains of promoters. 
There are, however, well-recognized limitations to the econ- 
omy of large production in the single establishment,^" and of 
late there has been ever-increasing skepticism as to the net 
economy actually attributable to combinations. Undoubtedly 

9 See Vol. I, pp. 388-393. 

10 See Vol. I, pp. 3&1-392. 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 519 

the merging of a number of old plants has sometimes effected 
an immediate improvement in the weaker ones. A new broom 
sweeps clean. This movement chanced to be contemporane- 
ous with the developing of "efficiency engineering" and of 
"scientific cost-accounting," and these better methods, al- 
ready developed and applied in comparatively small plants, 
could be more quickly extended to the other plants brought 
into the combination. Moreover, the personal organizations 
in the separate enterprises had been brought to a high state 
of efficiency by the stimulus of competition, and there is rea- 
son to fear that, after some years of centralized bureaucratic 
organization, much of this efficiency may be lost. 

There seems no doubt that the strong motive for forming 
combinations is the profit to the organizers.^^ Whatever was 
the more generous motive or more fundamental economic rea- 
son assigned by the promoters, the investing public confi- 
dently expected that higher prices would be the chief result. 
There are indirect as well as direct gains to the promoters of 
a combination. There is the gain from the production and 
sale of goods to consumers, and there is the gain from the 
financial management, from the rise and fall in the value of 
stock. The promoters of a combination often expect to make 
from sales to the investing public far more than from sales 
to the consumer of the product. A season of prosperity and 
confidence, when trusts and their enormous profits are con- 
stantly discussed, has an effect on the public mind like that 
of the gold discoveries in California and in the Klondike. 
Then is the time for the promoter to offer shares without limit 
to investors. 

§ 16. Monopoly's power to raise prices. There is no 
doubt that the formation of a combination from competing 
plants can and does give a control over prices, a monopoly 
power, not possessed by the separate competing establish- 
ments. The same kind of power might be attained by the 
growth of one establishment outstripping all its competitors, 

11 See Vol. I, p. 334, on the function of the promoter. 



520 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

or by a new enterprise coming into the field backed by power- 
ful capitalists. But this would work slower and less exten- 
sive results than does the formation of a combination. 

Of course, the fundamental principles of price cannot be 
changed by a trust; a selling monopoly can affect price only 
as it affects supply or demand.^^ The strongest trust yet 
seen has not been omnipotent. Many careless expressions on 
the subject are heard even from ordinarily careful writers 
and speakers: "The trust can fix its own prices," "has un- 
limited control," "can determine what it will pay and for 
what it will sell." This implies that trusts are benevolent, 
seeing that the prices they charge are usually not far in excess 
of competitive prices in the past. Such a view overlooks the 
forces that limit the price a monopoly can charge. If the 
supply remains the same, no trust can make the price go 
higher.. The monopoly usually directs its efforts toward af- 
fecting the supply, leaving the price to adjust itself. It can 
affect the supply either by lessening its own output or by in- 
timidating and forcing out its competitors. It is true that this 
logical order is not always the order of events. The trust 
may not first limit the supply and then wait for prices to 
adjust themselves; it may first raise its prices, but, unless it 
is prepared to limit the supply in accordance with the new 
resulting conditions of demand, such action would be vain. 
The control of the sources of supply is the logical explanation 
of the higher price, even though the limitation of supply is 
effected later by successive acts found necessary to maintain 
the higher price. 

The report of the Federal Industrial Commission, which 
from 1898 to 1901 investigated the trusts, showed^^ that im- 
mediately upon their formation the industrial combinations 

12 See Vol. I, pp. 80-85, 382-387, 394-396. 

13 A summary of this evidence is given in tlie author's "Principles oi 
Economics" (1904), pp. 327-330. A fuller outline of the results of the 
Commission's conclusions may be found in "The Trust Problem," by J. 
W. Jenks, who acted as expert in the investigation. 



Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 521 

had raised their prices. Prices might be lowered again, but 
only when and where competition became troublesome, thus 
causing either "price- wars" or discrimination. 

Referexces. 

Bolen, G. L., Plain facts as to the trusts and the tariff. 1902. 

N. Y. 
Collier, W. M., The trusts. N. Y. Twentieth Century Press. 1900. 
Cotter, A., The authentic history of the United States Steel Cor- 
poration. N. Y. Moody magazine book Co. 1916. 
Hflhson, J. A.. The evolution of modern capitalism. N. Y. Scribner. 

1912. Ch. V. 
•Tones, Eliot, The anthracite coal combination in the United States. 

Harvard Univ. Press. 1914. 
King, 'W. /., The wealth and income of the people of the United 

States. N. Y. Macmillan. 1915. 
Meade, E. 8., Trust finance. N. Y. Appleton. 190.3. 
Montague, G. H., Trusts of to-day. N. Y. Douhleday. 1904. 

( Favorable. ) 
Ripley. W. Z., (Ed.), Trusts, pools and corporations. Ed., 1916. 
Stevens. W. 8.. (Ed.), Industrial combinations and trusts. N. Y. 

Macmillan. 1913. 
8tevens, W. 8., Unfair competition. Univ. of Chicago Press. 1916. 



CHAPTER 31 
PUBLIC POLICY IN RESPECT TO MONOPOLY 



§ 1. Moral judgments of competition and monopoly. § 2. Public char- 
acter of private trade. § 3. Evil economic effects of monopolistic price. 
§ 4. Common law on restraint of trade. § 5. Growing disapproval of 
combination. § 6. Competition sometimes favored regardless of results. 
§ 7. Increasing regard for results of competition. § 8. Common-law 
remedy for monopoly ineffective. § 9. Federal legislation against mo- 
nopoly. § 10. Policy of the Sherman Anti-Trust Law. § 11. Policj- 
of monopoly accepted and regulated. § 12. Field of its application. 
§ 13. The industrial trust,— a natural evolution? § 14. Artificial 
versus natural growth. § 15. Kinds of unfair practices. § 16. 
Growing conception of fair competition. § 17. The trust issues in 
1912. § 18. Anti-trust legislation of 1914. § 19. Guiding principles 
of the new policy. § 20. Some early fruits. 

§ 1. Moral judgments of competition and monopoly. 
What should be the attitude of society toward monopoly? Is 
it good or bad as compared with competition? Some very 
strong ethical judgments bearing on practical problems are 
found in the popular mind connected with the ideas of com- 
petition and monopoly. Competition usually is prorfounced 
bad when viewed from the standpoint of the competitors who 
are losing by it, and good when viewed from the stand- 
point of the traders on the other side of the market who gain 
by that competition. Competition among buyers thus ap- 
pears to sellers to be a good thing ; that among sellers appears 
to themselves to be a bad thing (and vice versa). Many per- 
sons are moved by sympathy to pronounce competition among 
low-paid and underfed workers to be bad, and each worker 
is convinced that it is so in his own trade. Yet nearly all 
men are of one mind that competition is a good thing in most 

522 



en. 31] PUBLIC POLICY IN EESPECT TO MONOPOLY 523 

industries, those that are thought of as supplying the "gen- 
eral public. ' ' Monopoly is believed by the public to be wrong 
in such cases, and competition to be the normal and right 
condition of trade. Yet there are some men interested in 
"large business" who look upon competition as bad, and upon 
monopoly as having essentially the nature of friendly co- 
operation. The roots of these opinions, or prejudices, are 
easily discoverable in the theoretical study of the nature of 
monopoly.^ Yet often different men or groups of men feel 
so stronglj' on this matter, viewing it from their own stand- 
points, that they are quite unable to understand how any one 
else can feel otherwise. There is thus a great deal of con- 
troversy to no purpose. 

§ 2. Public character of private trade. Any such gen- 
eral judgment as that of the public, though it may be mistaken 
in some details, is likely to be a resultant of broad experience. 
There is in competitive trade a public, a social character, 
which monopoly destroys. Even in a simple auction, when 
the bidding is really competitive, price depends far less on 
shrewd bargaining, on bluff, or on stubbornness, than is the 
case in isolated trade. Each bidder is compelled by self-in- 
terest to outbid his less eager competitors, and thus the limits 
within which the price must fall are narrowly fixed. The 
auction-sale is less a purely personal matter, takes on a more 
public aspect, has a more socialized character, than isolated 
trade, depends more on forces outside the control of any one 
man, and results in a price fixed with greater definiteness. 
The price in a more developed market results from the play 
of impersonal forces, or at least from the play of personal 
forces which have come under the rules of the market.^ This 
price, men are read}' to accept as fair. It has a democratic 
character, whereas the gains of monopoly price arouse resent- 
ment as being the work of personal power and felt to be des- 
potic. Monopoly price is a bad price to the one who pays 

1 See Vol. I, especially pp. 74 and 75. 

2 See Vol. I, pp. 59, 68, 70, 71. 



524 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

it, not only because it is a high price but because it bears the 
character of personal extortion. 

The medieval notion of justum pretium, the just price, may 
have been often misapplied, and it was often criticized and 
ridiculed by economists in the period of idealized competition 
(from Adam Smith to John Stuart Mill). But at the heart 
of the notion was the judgment that general uniform prices 
fixed in the open market are the proper norms for prices 
when one of the traders is caught at an exceptional disad- 
vantage. The modern world has been compelled to reexamine 
the conception of the just price. 

§ 3. Evil economic effects of monopolistic price. The- 
oretical analysis confirms this view. Any exercise of monopo- 
listic power over price keeps some, the weaker bidders, from 
getting any of the desired goods, or limits them to their most 
urgently desired units. What may be called the "theoret- 
ically correct price ' ' ^ with two-sided competition is the one 
that permits the maximum number of trades with a margin 
of gain to each trader. In narrowing the possibility of sub- 
stitution of goods by trade, the sum of values of goods for 
most men is diminished. Thus all citizens who are the vic- 
tims of an artificially created scarcity look upon monopoly 
as "bad," just as they do upon the evils of nature — drought, 
locusts, fires, and pestilence. A monopoly has an indirect and 
more distant bad effect upon the spirit of all those trading with 
it. If they are producers selling at prices depressed by mo- 
nopoly, their money incomes are reduced; if they are con- 
sumers buying at monopoly prices, their real incomes are re- 
duced; in either case, their psychic incomes, the motives of 
all industry, are diminished and their industrial energies are 
relaxed. 

§ 4. Common law on restraint of trade. The first re- 
corded case in English laiw wherein the courts sought to pre- 
vent the limiting of competition by agreement runs back to 
the year 1415, in the reign of Henry V. This was a very 

3 See Vol. I, pp. 66, 67. 



Cil. 31] rUBLIC POLICY IX RESPECT TO MONOPOLY 525 

simple case of a contract in restraint of trade, whereby a dyer 
agreed not to practise his craft within the town for half a 
year. The court declared the contract illegal (and hence 
unenforceable in a court), and administered a severe reproof 
to the craftsman who made it. Thus was set forth the doc- 
trine of the moral and legal obligation of each economic agent 
to compete fully, freely, and without restraint, even re- 
straint imposed by a contract voluntarily entered into for 
his own advantage. 

Not until the eighteenth century was this rigid doctrine 
somewhat relaxed so as to permit the sale of the ''good-will" 
of a business under limited conditions, and some "reason- 
able" contracts in restraint of trade. Later the emphasis 
was somewhat further shifted, by judicial interpretations, 
from the notion of free competition to that of "fair" com- 
petition, so as to permit contracts involving moderate restraint 
of trade, if the essential element of competition was retained. 
Thus it was said that a piano manufacturer might by con- 
tract grant an exclusive agency to a dealer in a certain ter- 
ritory, there bieing many other competing makes of pianos, 
and such a contract "does not operate to suppress competi- 
tion nor to regulate the production or sale of any commod- 
ity."* But with such moderate limitations the courts in 
cases under the common law have steadily disapproved con- 
tracts in restraint of trade that would appear to be to the 
disadvantage of third parties, whether producers or con- 
sumers. 

§ 5. Growing disapproval of combination. The attitude 
of the courts became in one respect stricter. Some earlier 
cases involved the doctrine that what is lawful for an indi- 
vidual to do alone is lawful if done in combination with oth- 
ers. Indeed, a comparatively recent case ^ declared, regard- 
ing a group of dealers agreeing not to deal with another, that 

4 77 Miss., 470. Cited by Bruce Wyman, "Control of tlie Market," p. 
137. 

6 19 R. L, 255. 



526 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

"desire to free themselves from competition was a sufficient 
excuse" for such action. But the general trend has been to 
the doctrine that a combination of men "has hurtful powers 
and influences not possessed by the individual." Hence 
threats of associations of traders (retailers or wholesalers) 
not to deal with another if he continued to doal with some 
third party have been declared acts in restraint of trade.^ 
Yet in the case cited the court seemed to have been more con- 
cerned with protecting "the individual against encroachment 
upon his rights by a greater power," "one of the most sacred 
duties of the courts," than with rights and interests of the 
general public endangered by such restraint of trade. 

§ 6. Competition sometimes favored regardless of re- 
sults. In another respect the courts have wavered in their 
attitude toward competition, the general doctrine being that 
competition, particularly the cutting of prices, is absolutely 
justifiable, regardless of circumstances. In the leading Eng- 
lish case ^ the facts were that the larger steamship companies 
sent to Hankow additional ships, now called, figuratively, 
' ' fighting-ships, " to " smash ' ' freights in order to ruin tramp 
steamship owners and drive them out of the field. The court 
held that this constituted no legal wrong to the tramp steam- 
ship owners, and scouted the idea of the court's looking at 
the motives in price-cutting, or taking into consideration in 
any way what the court called "some imaginary normal stand- 
ard of freights and prices." And of this case the lawyer is 
forced to say: "Undoubtedly the excellent opinion just 
quoted represents the law everywhere, ' ' even though there are 
other cases difficult to harmonize with it.® 

To the economist, not bound in like manner by legal prece- 
dent, such a verdict seems short-sighted and mistaken. The 
court appears to have considered only the rights of the 
private litigants, the tramp steamship owners, not the 

6 115 Ga., 429. 

7 Mogul Steamship Company v. McGregor (L. R. 23 Q. B. D. 598). 

8 Bruce Wyman, "Control of the Market," p. 22. But see next §. 



Ch. 31] PUBLIC POLICY IX RESPECT TO MONOPOLY 527 

rights and interests of the shippinp: public ; it considered 
the immediate and not the ultimate effects of the "smashing" 
of rates; it allowed itself to be deceived by the appearance 
of acts that in outer form were competition, but that had as 
their purpose the strengthening and maintenance of monop- 
oly. These acts are forms of the "unfair" practices that 
will be mentioned later.^ 

§ 7. Increasing regard for results of competition. De- 
spite the binding precedents, the courts in some later deci- 
sions have refused to look upon competition as good regard- 
less of its motives and of its consequences. In a federal 
case ^° the judge, in a brief and acute dictum, recognized the 
evil of a rate war that would result from threats of definite 
cuts. They impair "the usefulness of the railroads them- 
.selves, and cause great public and private loss." The court's 
opinion was no doubt largely influenced by the fact that rail- 
road rates were already subject to regulation: "Every pre- 
caution has been taken by state legislatures and by the Con- 
gress to keep them just and reasonable, — just and reasonable 
for the public and for the carriers." 

In a state case ^^ the facts were that a man of wealth started 
a barber-shop and employed a barber to injure the plaintiff 
and drive him out of business. The court recognized that 
while, as a general proposition, "competition in trade and 
business is desirable," it may in certain cases result in 
"grievous and manifold wrongs to individuals"; and in this 
case the "malevolent" man of wealth was declared to be 
"guilty of a wanton wrong and an actionable tort." The 
economist can but pronounce this judgment admirable as far 
as it goes, but it is remarkably confined to a consideration of 
the private legal rights of the injured competitor, and gives 
hardly a hint of a higher criterion for judging competitive 
acts, that of the general welfare, 

9 See below, § 15. 

lOAverrill v. Southern Ruilway (75 Fed. Rep. 736). 

11 107 Minn. 145. 



528 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

The further enlightenment of judicial opinion upon the 
subject of cutthroat competition used as a tool to create 
monopoly was shown in the granting of an injunction by a 
federal court, in 1914/^ restraining the use of ''fighting- 
ships" by a combination, and by the indication in 1915 ^^ of 
the willingness to grant a similar injunction if necessary. 
Similarly "fighting brands" of goods have been recently pro- 
hibited. 

§ 8. Common-law remedy for monopoly ineffective. The 
common law contained prohibitions enough, both broad and 
specific, against contracts and acts in restraint of trade. The 
common law contained likewise a closely related body of doc- 
trine by which the railroads, as common carriers, ought to 
have given equitable and undiscriminating rates to all ship- 
pers. There was a strong body of influential opinion that 
long maintained that the common law was sufficient to prevent 
monopoly, that the only thing needed was to enforce it. Even 
now, after all that has elapsed, there are some in railroad and 
business circles who still appear to hold that opinion. But 
the evils of railroad discrimination and of other monopolistic 
practices continued, and for some cause the common law was 
not enforced, excepting occasionally, disconnectedly, and 
without important results. 

Why? The answer may be ventured that in the common 
law the whole question of restraint of trade was treated pri- 
marily as one of private rights and only incidentally as one 
involving general public policy. Cases came before the 
courts only on complaint of some individual who felt injured. 
Now the injury of higher prices due to contracts in restraint 
of trade is usually diffused among many customers, and 
the loss of any one is less than the expense of bringing suit. 
Consequently, it rarely happened that cases were brought be- 
fore the courts except by one of the two equally guilty parties 
to a contract in restraint of trade, when the other party had 

12 216 Fed. 971. 

13 220 Fed. 235. 



I 



Cir. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 529 

failed in some way to do his part. When such an illegal con- 
tract in restraint of trade was proved before a court by a 
defendant in a civil suit, the contract was declared unenforce- 
able, and the only penalty in practice was that the plaintiff 
could not collect his debt or secure performance from the 
defendant.^* A very similar situation existed in the case of 
the individual's grievances against railroad charges and serv- 
ices. 

§ 9. Federal legislation against monopoly. The passage 
of the Interstate Commerce Act in 1887 ^^ prohibiting dis- 
crimination and railway pooling, and that of the Act of 1890 
"to protect trade and commerce against unlawful restraints 
and monopolies," popularly known as the "Sherman Anti- 
trust Law," were part of one public movement to remedy 
monopoly. From one point of view it seems true, as has 
often been said, that in essence these statutes were simply 
enactments of long-established principles of the common law. 
Section 1 of the Sherman law declared illegal "every con- 
tract, combination in the form of trust or otherwise, or con- 
spiracy, in restraint of trade or commerce among the several 
states, or with foreign nations." Section 2 made it a mis- 
demeanor "to monopolize, or attempt to monopolize." 

But, from another point of view, these new laws showed a 
marked change both in the conception of the interests in- 
volved and in the means of preventing the evils. The evil 
was at last conceived of as a general public evil ; the laws 
are not merely to protect individuals,^* but "to regulate com- 
merce," "to protect trade and commerce." More important 
still, it was made the duty of public officers (district attorneys 
of the United States) to institute proceedings in equity "to 
prevent and restrain" violation of the Sherman Act, and a 

"Ariiott V. Pittston and Elmira Coal Co., 68 N. Y. 558 (1877). 

15 See ch. 29. § 15. 

ic At the same time the rights of injured individuals are better safe- 
guarded by section 7 of the Sherman law. permitting the recovery of 
three-fold damages and attorney's fees. 



530 PUBLIC POLICY TOWAED PRIVATE INDUSTRY [Pt. V 

special Commission was instituted to deal with railroad cases. 
It was this undertaking of the initiative by the government, 
the treatment of the problem as one of the general welfare, 
that marked a new epoch in this field. The methods and 
agencies provided might be at first inadequate and ineffec- 
tive, but time and eitperience could remedy those defects. 

In important ways opinion and policies were not yet clear 
and consistent. They wavered from one to another conception 
of the method for dealing with the problem. It was clear only 
that laissez-faire had been laid aside. There are three other 
possible policies, reflecting as many different conceptions of 
the problem of monopoly: (1) monopoly prosecuted, (2) mo- 
nopoly accepted and regulated, (3) competition maintained 
and regulated. 

§ 10. Policy of the Sherman Anti-Trust Law. The policy 
of monopoly prosecuted embodied in the Sherman law is 
merely negative. It opposed no positive action to the mak- 
ing of monopolistic contracts and to the formation of com- 
binations, but declared them to be illegal and provided for 
their prosecution and punishment after the mischief had 
been done. The great epoch of the formation of combina- 
tions ^^ followed the enactment of this law. True, lack of 
experience by the department of justice, and lack of vigor- 
ous effort to enforce the law, and the slow action of the 
counts were largely to blame for this result. The law has 
proved to be more effective to prevent new combinations, 
since it has been successfully enforced in a few notable 
cases. But once large combinations have been formed and 
complex individual financial interests have become involved, 
the courts have proved to be incapable of undoing the deeds. 
In practice the most sweeping remedy attempted under the 
law has been the dissolution of enormous combinations 
formed years after the law went into effect. This has been 
called the job of unscrambling the eggs. The most notable 
cases were those of the Standard Oil Company and of the 

17 See ch. 30. § 8. 



Cir. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 531 

Tobacco Company, decided in 1911, the results being absurdly 
futile. 

§ 11. Policy of monopoly accepted and regulated. A sec- 
ond policy may be called that of monopoly accepted and regu- 
lated. This is represented by the Interstate Commerce Act 
(at first weakly, and more vigorously after its amendment), 
and by the great mass of state legislation putting the local 
and interurban public utilities under the control of regula- 
tive commissions. For some decades after these industries 
developed, the public faith was in competition as the effective 
regulator. If monopolistic prices were too high, another com- 
pany was chartered to build a parallel railroad or another 
horse-car line on the next street, or to lay down another set 
of gas-pipes in the same block. Almost from the first, some 
students of the subject saw the wastefulness and futility of 
this kind of competition, and nearly a half -century later the 
public reluctantly came to this view. Still, sad to relate, the 
same history had to be repeated in regard to the telegraph 
and telephone industry, and in some quarters the ultimate 
outcome is not yet recognized. The Interstate Commerce 
Act itself, with odd inconsistency, contains an anti-pooling 
provision (Section 5), the purpose of which seems to have been 
to compel competition as to rates, which is now practically im- 
possible under the other provisions of the law. The policy 
of "monopoly accepted" iwas seen to involve as a necessary 
feature public regulation of rates to the point, if necessary, 
of absolutely fixing them. The principle has come to be ac- 
cepted that wherever competition ends there public regula- 
tion of prices and service begins. Monopolistic enterprises 
are ipso facto quasi-public institutions. 

§ 12. Field of its application. This policy, gradually ex- 
tending in practice, came to be applied to the class of indus- 
tries which, for lack of a better name, are called local utili- 
ties. The one characteristic that they all have in common 
is that the service, or product, which is sold requires for its 
delivery some special use of public highways and an expen- 



532 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

sive, permanent, physical plant, such as gas-pipes, water- 
pipes, poles and wires. The telegraph, the telephone, electric 
lighting, street railways, regular steam railroads, and some 
other minor industries all answer to this test.^® 

Beginning about the year 1900, one state after another 
enlarged the powers of its state railroad commission or cre- 
ated a new corporation commission to regulate these "local" 
or "public utilities."^'' They have accomplished much, but, 
the development of this kind of regulation has not proceeded 
in many cases beyond the adjustment of relative rates and 
the abolition of discrimination among the different individ- 
uals and classes of customers. Experience has shown the 
great difficulty of determining what is a fair absolute level 
of charges. A new science of accounting has been develop- 
ing to assist in the solution of a problem the compi^exity of 
which transcends the agencies at hand to deal with it. With 
this policy applied to the local utility (and railroad) phase 
of monopoly, there remains still the problem of the industrial 
trusts in the manufacturing enterprises. 

§ 13. The industrial trust — a natural evolution? The 
policy that one is inclined to favor regarding industrial trusts 
depends very much on one's answer to the question: Are or 
are not industrial trusts natural growths ? In this bare form 
the question is somewhat vague, but the thought of those who 
answer it in the affirmative is positive if not always entirely 
clear. They (at least, the extreme representatives of this 
view) declare that trusts have been, are, and will continue to 
be the results of a "natural evolution" of business condi- 
tions, as inevitable as the great changes in the physical world. 
If this is so, man and society must recognize the facts, must 
waste no efforts vainly in fighting against fate, but must 
accept the trusts and realize their possibilities for good. And 
these are declared to be great, for it is assumed that without 
the trusts all of the economies of large production must be 

18 See further, ch. 32, §§ 5-9. 

19 See ch. 29, § 3, on state condmissions. 



Ch. 31] PUBLIC POLICY IX RESPECT TO MONOPOLY 533 

sacrificed. Irresistible economic forces, it is said, are creating 
larger and larger units of business; friendly cooperation and 
unified action must take the place of competition in business. 

The outcome must be monopoly in every important line of 
manufacturing industry and perhaps of commerce. In view 
of public opinion toward monopoly, its acceptance necessi- 
tates its regulation. This argument is supported by appeal 
to the experience in the field of railroads and other local utili- 
ties, where public opinion has, after long hesitation, recog- 
nized competition to be impracticable and the acceptance of 
monopoly as inevitable. As extremes often meet, the view 
of the industrial trust as a natural evolution is most favored, 
on the one hand, by men of ' ' big business, ' ' already interested 
financially in trusts, and, on the other hand, by the most radi- 
cal communists (or socialists) whose ideal is the complete 
monopolization of industry under the government.- 

§ 14. Artificial versus natural growth. Opposed to this 
view is a deep and widespread popular opinion, or prejudice, 
against the trust and in favor of competition. General opin- 
ion in this case (as not always) finds much support in special 
economic studies of the methods by which the existing indus- 
trial trusts came into being. First the question properly is 
raised : Just what is meant by * * natural " ? In a sense, every- 
thing has been the natural outcome of evolution — the steam 
engine, the submarine, the boycott, militarism. In an equally 
good if not better sense, every mechanical invention and 
every method of industrial organization is artificial, has been 
the result of man's choice and effort. In any case, men may 
choose as good, or reject as unsuitable or bad, any particular 
mechanical device, and society may decide to adopt any par- 
ticular policy toward a certain form of business organization 
and certain business practices (unless, indeed, our philosophy 
be that of automatism, crude determination or fatalism, re- 
garding all human affairs). 

Now, when one examines the methods that the notable 
trusts actually did employ, and apparently had to employ, 



534 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

even when they were already powerful single enterprises, in 
order to destroy their competitors and to attain their monopo- 
listic power, the word "natural" seems hardly to describe 
the process. The evidence is not a matter of hearsay, but is 
embodied in a long line of judicial decisions, and in numerous 
special inquiries by governmental commissions and officials. 

§ 15. Kinds of unfair practices. This evidence is a star- 
tling array of "unfair practices" and "unfair" forms of 
competition, which, however novel in appearance, are essen- 
tially of the kind that have been illegal under the common law 
for the past five hundred years. Many of these practices 
were baldly dishonest, many of them were contemptibly mean. 
The manifold varieties of unfair competition may be roughly 
grouped under three headings, according as they are connected 
with (1) illegal'', favors received from public or quasi-public 
officials; (2) discrimination against, or control of, custom- 
ers; (3) foul tactics against competitors. 

(1) Among the practices in the first group are discrimina- 
tory rates and rebates from railroads, favoritism in matters 
of taxation, undue influence in legislatures, special manipula- 
tion of tariff rates through powerful lobbies or paid agents, 
undue influence in the courts through the employment of law- 
yers of the highest talent, who often later became judges. 

(2) Among the unfair practices toward customers are dis- 
criminations among them by the various forms of price-cut- 
ting, grants of credit, and kinds of service. The liberty of 
retail dealers is limited, in a variety of ways, such as fixing 
resale prices, requirement of exclusive dealing, and full-line 
forcing. 

(3) All the methods just mentioned as employed in deal- 
ings with customers are likewise unfair toward competitors. 
Many other methods are used to the same end, such as : entic- 
ing away their employees, or corrupting and bribing them 
to act as spies, paying secret commissions, false advertising, 
misrepresenting competitors, imitating their patterns in goods 
of defective workmanship, shutting off their credit or their 



Ch. 31] PUBLIC POLICY IX RESPECT TO MONOPOLY 535 

supplies of materials, acquiring stock in competing compa- 
nies, malicious suits, infringement of patents, intimidation by 
threats of business injury or of scandalous exposures, opera- 
tion of bogus independent companies. 

§ 16. Growing conceptioii of fair competition. Any in- 
dustrial trust that was able to gain domination and monopoly 
power only by the use of such practices, or any part of them, 
can hardly be deemed the result of a "natural evolution." 
If "artificial" means the use of artifices, surely this develop- 
ment deserves the adjective. Yet, even if not natural, this 
development may be thought to be "inevitable," human na- 
ture being as it is. But the bald fact is that while the great 
trust movement was in progress no effort worthy of the name 
was being made to enforce even the then existing laws and 
to oppose this artificial development. The same allegation of 
inevitableness was once commonly made of discriminatory 
railroad rates and rebates, evils that have been in large part 
remedied only since the period 1903-1906, when at last in- 
telligent action was taken. 

To those who came to see the problem in this light, accept- 
ance of industrial monopoly, with its complex task of fixing 
by public commission the prices' on innumerable kinds and 
qualities of goods, seemed at least premature. Rather, the 
first step toward a solution seemed to be the vigorous preven- 
tion of unfair practices, and the next step a positive regular- 
izing of "fair competition." The fundamental idea in this 
is the enforcement of a common market price (plus freights) 
at any one time to all the customers of an enterprise. By 
this plan, potential competition would become actual, and 
small enterprises that were efficient might compete success- 
fully within their own fields with large enterprises that main- 
tained prices above a true competitive level. Even general 
lowering of prices by a large enterprise with evident purpose 
of killing off smaller competitors is unfair competition under 
this conception. It was for years recognized that the realiza- 
tion of this policy required legislation regarding uniform 



536 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [^T. V 

prices and the creation of a commission for the administra- 
tion of the law. 

§ 17. The trust issues in 1912. The campaign of 1912 
presented in an interesting manner the three policies above 
outlined. The Republican party, led by President Taft, stood 
for the policy of monopoly prosecuted; its program was the 
vigorous enforcement of the Sherman law. The Progressive 
party, led by Mr. Eoosevelt, stood in the main for the policy 
of ' ' monopoly accepted and regulated " ; its program called 
for minimizing prosecution and for retaining trusts under a 
system of regulation. The Democratic party, led by Mr. 
"Wilson, stood for the policy of competition maintained and 
regU(\ated, and the problem was to find means to strengthen 
and regularize the forces of competition. 

In practice these programs doubtless are less divergent 
than they appear. All alike proposed the retention of the 
Sherman law. The two proposals to go further were pre- 
sented as mutually exclusive alternatives, whereas they nec- 
essarily must supplement each other in some degree. The 
Progressives did not expect all industries to become monopo- 
lies, and the Democrats tacitly conceded to monopoly accepted 
the large field of transportation and local utilities it already 
had occupied. But there was a real difference in the angle 
of approach and a real difference in emphasis. The Demo- 
cratic program (though somewhat unclearly) showed greater 
distrust of monopo/y and greater faith in the possibilities of 
creating fair conditions of competition (which never had fully 
prevailed) in which efiiciency would be able to prove its mer- 
its and monopoly would work its own undoing. It is more 
logical for the country to give this policy an adequate trial 
before adopting irrevocably the policy of general industrial 
monopoly. In either case, competition actual or potential is 
the fundamental principle by which prices have to be regu- 
lated. Where competition is enforced it is by applying some 
general rules that create a general market price instead of 
discriminatory prices, but the fixing of the price is left to the 



Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 537 

competitors. Where monopoly is accepted prices must be 
fixed with reference to an estimated competitive standard, 
tliat which under hypothetically free conditions would just 
suffice to attract and retain private enterprise and capital. 

§ 18. Anti-trust legislation of 1914. The anti-trust legis- 
lation of 1914, passed by the Democratic party to carry out 
its program, is embodied in two acts: the Clayton Act and 
the Federal Trade Commission Act. The Clayton Act for- 
bids discrimination where the effect may be to lessen com- 
petition or tend to create a monopoly, and lays down new 
rules for determining fair prices. It permits due allow- 
ance to be made for differences in the cost of selling or 
transportation, but a difference is not required in such cases. 
It forbids contracts to prevent dealers from handling other 
brands. It forbids corporate ownership of stock in a com- 
peting corporation, forbids interlocking directorates in large 
banks and in other competing corporations, with capital, sur- 
plus, and undivided profits aggregating more than $1,000,000. 
The Federal Trade Commission Act provided an agency with 
administrative and quasi-judicial functions to deal with unfair 
practices, displacing the Bureau of Corporations, established 
in 1903. In addition to its administrative provisions for 
investigation, reports, and readjustment of the business of 
companies upon request of the courts, the act declares that 
"unfair methods of competition in commerce" are unlaw- 
ful, and both empowers and directs the Commission to pre- 
vent their use (banks and common carriers subject to other 
acts being excepted). 

§ 19. Guiding principles of the new policy. The Cora- 
mission in March, 1915, began its work. Only two years later, 
and for the next three years, it was called upon to give a 
large part of its efforts to aiding other governmental agencies 
in their war-time and post-bellum work, especially in cost- 
fixing investigations, and coidd not adequately perform its 
original task. At the end of six years, many of the evils 
which the Commission was designed to correct still prevailed. 



538 PUELIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 

The price advances within that period had been so swift and 
bewildering that they obscured all distinctions of normal 
demand, normal supply, fair price, war profiteering, and 
monopoly. For example, investigations in 1921 in New York 
and other cities revealed incredible monopolistic practices in 
the building industries, by labor and capital alike. 

But for all this it cannot be doubted that a new and potent 
agency for creating higher business standards has been 
brought into existence. The new legislation drew the atten- 
tion of the country to the development of a better commercial 
morality. Many business men wrote to the Commission com- 
mending the purposes of the law, and offering their cooperg- 
tion to eradicate long standing practices which they deplored. 
The Commission admirably declared that it iwas seeking "to 
understand and make allowance for the difficulty of the prob- 
lem, to see both sides of every case, to protect men in the 
furtherance of legitimate self-interest by all reasonable and 
normal methods, and at the same time to keep the channels 
of competition free and open to all, so that a man with small 
capital may engage in competition with powerful rivals, as- 
sured that he may operate his business free from harassment 
and intimidation and be given a fair opportunity to work 
out his business problems with such industry, efficiency, and 
intelligence as he may possess." 

§ 20. Some early fruits. Through the investigations of 
its economic division the Commission has collected a stupen- 
dous mass of detailed information on the conditions and the 
trade practices in many of the leading industries of the coun- 
try, throwing the light of publicity into many a dark corner 
of commercial abuses. 

The legal division of the Commission at the end of its 
first five years had received almost exactly two thousand ap- 
plications for complaints (for unfair practices and violation 
of the Cay ton Act), upon which it had made inquiries and 
dismissed about one half without publicity. The number of 
these had increased each year, more than one third having 



Cir. 31] rUBLlC POLICY IN RESPFXT TO MONOPOLY 530 

been in the last year. The Commission had in more than six 
hundred of these eases issued formal complaints, of which 
more were in the last year than in the i^revious four years. 

In takinf; up these complaints the names of the complain- 
in«7 parties are not disclosed. The Commission's work is 
primarily to protect the public interest and not merely to 
intervene in "contests between individuals in relation to 
their private rights." On this theory, the Commission may 
and does institute proceedinors "on its o\^^l motion without 
charges being made to it or upon application of parties not 
directly affected by the practices complained of." This 
present policy in respect to monopoly stands out in striking 
contrast to the theory of the private litigant and the injured 
party as embodied in the preceding law and practice. It 
still remains to be seen whether, in the near future, it will 
be possible to scotch the snake of monopoly and give to the 
"common man" the chance to live and work according to 
fair rules of the game in business enterprise. 

References. 

Bolen. G. />.. Plain facts as to the trusts and the tariff. 1002. 

N. Y. 
Urnv^'. W. ./.. The prevention and control of monopolies. N. Y. 

Dutton. 1915. 
Clark. J. /?., The problem of monoi)oly. X. Y. Lemeke. 1004. 
Clark, J. B., and J. M., Tlie trust problem. Doubleday. 4th ed. 

1017. 
Davirs. J. E.. Trust laws and unfair competition. U. S. V,\\y. of 

Corporations. 1016. 
EJy. /?. T.. Monopolies and trusts. N. Y. Macmillan. 1000. 
dnnufki/. C. E., Public utility rate fixing:. Journal of electricity 

technical book shop. 1018. 
Jrnkf!. J. W., The trust problem. Rev. ed. K. Y. Doubleday. 1017. 
Kinley, David, The renewed e.Ktenfsion of government control of 

economic life. A. E. Rev., 4 (no. 1, supp.) : 3-17. 1014. 
LeRossignol, J. E., Monopolies past and present. N. Y. Crowell. 

1000. 
Orth, 8. P., (Ed.), Readinj^s on the relation of government to prop- 

ertv and industry. Bost. Cinn. 1015. 
Itipley, ir. Z., (Ed.), Trusts, pools and corporations. Ed. Bost. 

Ginn". 1016. 
Turlerrille and Howe, Great Britain in the latest ape— from 

laisscz faire to state control. New York. Dutton. 1021. 
United States Industrial Commission, Report. 180S-1001. 10 vols. 
Wyman, Bruce, Control of the market. N. Y. Moffat. 1011. 



PART VI 
PRIVATE PROPERTY VERSUS SOCIALISM 



CHAPTER 32 



THE PRESENT ECONOMIC SYSTEM 



§ 1. The place of private property. § 2. Nature of property. § 3. 
Relation of wealth, property, and capital. § 4. Some theories of 
private property. § 5. Origin va. justification. § 6. Limitations of 
private property. § 7. Limitations of bequest and inheritance. § 8. 
Social expediency of private property. § 9. The monetary economy. 
§ 10. The competitive system. § IL Limitation of competition by 
custom. § 12. ElFect of modern forces upon custom. § 13. Adam 
Smith's influence. § 14. The wage-system. 

§ 1. The place of private property. Of fully equal im- 
portance with material wealtli in determining the economic 
power of a people is the social system under which the nation 
lives. This is the term applied to the whole complex of in- 
stitutions and arrangements in which and by which people 
live together in society. It is the embodiment of the opinions, 
ideas, and habits of life inherited by each generation from 
its forebears. It is, indeed, a people's whole state of civiliza- 
tion, with its political, economic, intellectual, scientific, re- 
ligious, and esthetic aspects. 

The most important economic aspect of the existing system 
is, broadly speaking, the institution of private property. So 
closely connected with this that they are hardly more than 
different phases of the same thing are the use of money (the 
monetary economy), the wage system, and competition as a 
mode of distribution. "The institution of private property" 
is the general expression for the way in which men in the 
modern state make use of their own energies and of material 
wealth within the nation. We live in a regime of private prop- 
erty, and all our economic problems are affected by that fact. 
The determination of the exact boundaries of private property 

543 



544 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

makes up a large part of the politico-economic problems 
which the people in each generation have to solve. A large 
share, possibly, in a certain sense, every one of the economic 
problems that are discussed involve change, limitation, defini- 
tion, or, more radically, abolition of present laws of property. 
Broadly understood, as above, therefore, determination of the 
nature of private property is the essential problem in eco- 
nomic legislation. 

§ 2. Nature of property. Property means ownership, 
and ownership is the abstract noun expressing the quaHty 
of possessing a thing. Correspondingly, owner is the 
Anglo-Saxon equivalent of "proprietor." Property thus, 
fundamentally, means, not an object held or possessed, but 
the right in or belonging to a person to control something 
that he owns. Ownership is a legal right to control under 
certain conditions.^ Physical possession of an object is not 
necessarily ownership. 

The law makes between property rights and equitable rights 
some subtle distinctions, which have their reason in the his- 
tory, if not in the logic, of the law, but which are not essential 
to economic discussion. In some states this distinction has 
been in large measure abolished. What interests us are the 
rights (claims) that men have to the control of wealth and 
services, whether by technical law these are called legal or 
equitable, and this right is what is meant by "property" in 
our discussion of it. 

There are different kinds of ownership. It may be private, 
as that of individuals, families, partnerships, or corporations ; 
or it may be public, as that of nations, states, counties, cities, 
and towns, owning such things as public buildings, parks, 
highways, the Adirondack forest reserve, or the Erie Canal. 
These two kinds are equally effective as against the claims of 
outsiders, but the rights of those inside the circle of ownership 
differ. For example, the rights of one shareholder against 

1 See Vol. I, pp. 264-267. 



Ch. 32] THE PRESENT ECONOMIC SYSTEM 545 

another, or the rights of one member of a family as against 
another, are not the same as the rights against outsiders. 
Private property is the characteristic feature of our present 
industrial society, but it exists side by side with public prop- 
erty and with many intermediate grades between private and 
common property. 

Though property meant originally and essentially the intan- 
gible right to a thing, the word came to be applied also to the 
object of the right. This is done both in common speech and 
in judicial decisions, with inevitable ambiguity. This may 
be readily seen by trying to substitute the word ownership 
for property, a thing quite simple in some cases but impos- 
sible in others. One would not point to a house and say, 
"This is my ownership," but either, "This is my property," 
or "I exercise ownership over it." It is well recognized that 
a man may have a property right in this abstract sense in or 
over his own services, as to practise a trade or in the "good 
will" of a business, or in an intangible patent or a copyright, 
quite as well as in a material object. 

§ 3. Relation of wealth, property, and capital. A fail- 
ure to see this distinction and to keep it clearly in mind has 
led to confusion, even on the part of legislatures, learned 
judges, and able economists. If property is said to be (for 
example) a house and lot and at the same time the right to 
that house and lot, then there are two properties at once for 
each economic good, viz. : the object itself and the right to it.* 

This difficulty could be avoided by the consistent definition 
and use of terms. A material economic object is a good, is 
a form of wealth. The usance of wealth and the service of 
laborers at the moment rendered constitute forms of income. 
The right of ownership, i. e., the right to control, use, or 
direct the use of wealth and services, is property, which is 
therefore the right to receive incomes. The value of the in- 

2 This confusion has had important practical consequences in the 
field of taxation. Sec Vol. 1, pp. 265-267. and alwvc, ch. 18. §§ .3-5. 



546 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

come of an individual constitutes his capital. Goods, rights 
to goods, value of rights to goods: these three things are 
clearly distinguishable. 

§ 4. Some theories of private property. Various theories 
have been framed to explain the origin and to justify the ex- 
istence of private property. The occupation theory is that 
property is based upon the priority of claim of one who finds 
wealth without an owner and appropriates it. This is not an 
explanation of the property rights that are arising every 
moment, nor does it give a logical reason for the continuance 
of ancient property rights. It is a statement applying to a 
case that has rarely happened, the settlement of an unoccupied 
territory. 

More adequate to explain many cases is the conquest theory, 
that property is based on force; for nearly all lands to-day 
are occupied by the descendants of conquering invaders who 
took the lands and natural resources from the former in- 
habitants, who in turn had taken them from other occupants 
many centuries before. The conquest theory applies, for ex- 
ample, to the invasion of the Roman provinces by barbarian 
tribes who divided the country and developed the feudal sys- 
tem based on land tenure. But it hardly applies to present- 
day happenings, and at its best it cannot, to modern minds, 
"justify" present property rights. 

The labor theory, meeting some queries where others fail, 
is that ownership is based on the act of production. It is 
declared that every man has a right to that to which his brain 
and his muscles have imparted value. It is apparent that this 
test leaves without explanation or justification a great num- 
ber of things that do exist and have existed as property. 
Usually the basis of the labor theory of property is declared 
to be each individual's natural right to the results of his own 
labor, which claim is assumed to be an ultimate, undebatable, 
axiomatic fact. However, that type of natural-right doc- 
trine, which makes no appeal to experience and results, is 
now quite discredited in political science. 



Cii. 32] THE PRESENT ECONOMIC SYSTEM 547 

Another form of rMtural-rights theory is that property is 
necessary for the realization of the dignity of human nature, 
and every individual has the natural right to self realization. 
This theory is, in a way, based on an appeal to experience as 
to the effect of property on human character, and it has the 
virtue of expressing one of the ideals of modern democracy. 
Although, in common with various other "natural-rights" 
theories, it must be deemed too absolute and too individualistic, 
it contains a far-reaching truth, of which due account must be 
taken in our social philosophy. 

The Jegdl theory is that property exists because the law 
says it shall. This expresses a truth, but is no more than a 
truism. The law determines the limits of property, but what 
determines the limits of the law? What practical or social 
justification is there for passing and continuing such law? 
The legal theory does not contain a final explanation. 

Each of the five theories has its defects, but each points to 
some fact important and significant, at certain times and 
places, in the explanation of this widespread institution. 
They al.' find some place within a more comprehensive sixth 
theory, that of social expediency, which will be outlined be- 
low. First, however, let us briefly survey some of the histori- 
cal and legal qualifications of property as it has been and is. 
§ 5. Origin vs. justification. The question of the origin 
is not the same as that of the present justification of the ex- 
isting system of private property. The institution of private 
property has evolved under diverse conditions. In early so- 
cieties individual property rights were not very clearly 
marked. Every tribe asserted against other tribes, and tried 
to uphold by war, its claims upon its customarj^ hunting- 
grounds; but the claims of the individual hunters on land 
within the tribe did not often come into conflict. Private 
property at the outset was in personal possessions, ornaments, 
weapons, utensils, which were very meager in that primitive 
society in which it was the custom "to go calling with a club 
instead of a card-case." Only later came individual property 



548 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

in land. A few years ago it was generally believed that the 
organization of the old German tribes was politically an al- 
most perfect democracy, and economically a communism in 
which all had equal claims upon the land. To-day this opin- 
ion is very seriously questioned. It seems probable that there 
was a goodly measure of communism in the control and use 
of lands (though not in other things), but this was largely con- 
fined to an oligarchy of the favored ; whereas the masses lived 
in subjection, cut off from all but a meager share in the com- 
mon lands. However that may have been, strong forces within 
historic times have put an end to the common ownership and 
tillage of land as it existed among the peasants of Europe. 
That system was shown by experience to be wasteful. Com- 
petition tended to bring the economic agents into more effi- 
cient hands, and the movement was furthered by many acts 
of injustice and violence on the part of those in power. 

Inquiries into the origin and development of any social in- 
stitution are interesting and helpful in forming an estimate 
of its present significance, but the problems of the past are 
not those of to-day. Whether or not the ancient beginning 
of property in Europe was in violence and evil has but a re- 
mote bearing on the question as to the present working of it. 
Social conditions and needs have not changed more than have 
the forms and limits of property itself. Each generation has 
its own problems to solve, and, ignoring for the most part the 
evils of the distant past, each generation must test existing in- 
stitutions by their present results. 

§ 6. Limitations of private property. It is well, in dis- 
cussing private property, to rid the mind at once of the idea 
that it is an absolute and unchanging thing. Few realize the 
manifold ways in which property rights are limited. Un- 
modified private control of property is unknown; the public 
makes many reservations in its own interest. There is, first, 
a whole set of limitations to prevent nuisances. An owner in 
many situations is not free to build a slaughter-house or to 
start a glue-factory on his land. Property is governed by 



Ch. 32] THE PRESENT ECONOMIC SYSTEM 549 

general public utility, and anything that threatens to beconic 
a nuisance or a danger may be excluded. Under the right of 
eminent domain, the state or the railroad may take the old 
homestead from the owner who would live and die there. 
Although pecuniary damages are paid to liim, this is a limita- 
tion of his property rights. Eights of ivay on property exist 
either by contract or by prescription permitting its public 
use. Most important of all limitations is the right of tax- 
ation, by which society takes more or less of private incomes 
for purposes of which the individual owners may not approve. 

The law enforces a multitude of private claims by some 
persons against others. A variety of rights called easements 
or servitudes may attach to private property, modifying its 
exclusive use. Leases for an}- period are a limitation of the 
owner's control. Both the holder of the lease and the owner 
of the property have certain rights before the law. The 
lender of money secured by mortgage has a legally recognized 
and enforceable equity in the mortgaged wealth. Property 
is left in trust for the benefit of persons or of institutions or 
of the public, and is administered by trustees who are strictly 
bound to execute the terms of their instructions. Contracts 
of many sorts are entered into by owners, limiting their con- 
trol in manifold ways, and the law enforces these contracts. 
These all form a complex of equitable claims, which together 
equal in value one undivided property right, which in turn 
equals the value of the wealth.-' These claims mutually de- 
limit each other (whether they be called equitable claims, or 
liens, or property rights), and wealth is not multiplied by 
multiplying the claims, as is unfortunately sometimes assumed 
to be the case. 

§ 7. Limitations of bequest and inheritance. The term 
bequest implies a will, usually a written will in ivvhich the 
person, in anticipation of death, expresses his wishes as to the 
disposition of his property. It is said sometimes tliat bequest 
is a " logical ' ' result of private property, but the law does not 

3 See § 3. 



550 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

treat it as necessary. The right of bequest, or of gift at death, 
is limited in various ways in different countries. In countries 
where hereditary aristocracies exist, primogeniture is in some 
cases required by law, in others so strongly favored by public 
opinion that it is practically always followed. Custom limits 
bequests in England to members of the family, and wills giv- 
ing outside the family are rare, and are almost always broken 
in the courts. John Stuart Mill contrasted this with the prac- 
tice in America, frequent even in his day and still more fre- 
quent now, of rich men giving for public purposes. In 
France the right of bequest outside the family is legally lim- 
ited; only the share of one child can be willed away by the 
father, and the rest must be equally divided among the chil- 
dren. "Settlements" and fidei commissa are limited in many 
countries because of the recognized socia^^. evils resulting from 
the tying up of estates for generations. Throughout the his- 
tory of England, Parliament has given attention to the ques- 
tion of mortmain, which chiefly concerned the drifting of great 
estates into the hands of the church or of corporations as the 
result of bequests by the pious. In England, of late (and to 
a less extent in this country), the policj^ of permitting unlim- 
ited endowments to charitable institutions has been seriously 
questioned, and by legislation some of the old endowments 
have been diverted from their original purposes when these 
have ceased to be of social utility. Inheritance, in contrast 
with bequest, usually means succession to the property of one 
who has died intestate, that is, has made no will. The law of 
inheritance likewise varies greatly with time and place. 

§ 8. Social expediency of private property. In the light 
of history and of present political philosophy, the explanation 
and justification of private property must be on grounds of 
social expediency: This is a broad explanation, and it has 
the fault of a broad explanation that it needs to be further 
explained. Under it can be brought the many varying con- 
ditions. Even if private property works hardships to in- 
dividuals in many cases, it may be justified if, on the whole, 



Cn. 32] THE PRESENT ECONOMIC SYSTEM 551 

it gives the best results that are practically possible. Laws 
must l)e judged by their average working, not by exceptional 
cases. In general, the system of private property must be 
judged by this test: Does it advance the welfare of the 
nation better than would any alternative plan for the control 
of economic wealth ? The question is not whether it is fault- 
less, for no human institution is so. Nor must it be assumed 
that the rule of property needs to be uniform in respect to 
all kinds of wealth. There are many kinds of property, 
and the test maj'^ be applied separately to the different forms 
and to the varying degrees of property rights. The varied 
and often strict limitations of property mentioned above are 
all determined by some thought, wise or foolish, of social ex- 
pediency. In the last chapter have been seen many examples 
of the fact that different parts of wealth may be treated in 
different ways : there may be private property in wagons, and 
public property in roads ; private property in houses, and 
public property in forests; private property in automobiles, 
and public property in railway carriages. But any rule 
of propert}^, like any other workable human law, must be 
applicable to all individuals who meet the conditions. 

The very acceptance of the theory of social expediency im- 
plies the need of frequent readjustment of the institution of 
private property. The essential thought in the various at- 
tacks on the institution of property is that, because it either 
causes or makes possible the inequality of incomes, it is not 
socially expedient. Private property, as it is found to-day, is 
complicated by many historical accidents. Survivals of 
ancient injustice and relics of feudal institutions that rest on 
no vital reason remain in our new country as well as in the 
older ones. The limits of property in many respects are de- 
termined, not according to the logic of expediency, but by the 
social inertia that often governs successive generations. 

The question is raised in many minds : If private property 
is not an absolute right, what shall be its limits? What 
changes should be made in it? These questions put one of 



552 PEIVATE PROPEETY VS. SOCIALISM [Pt. VI 

the greatest economico-political problems of our day, one that 
contains within it, indeed, the many minor problems that have 
appeared in the foregoing pages. 

§ 9. The monetary economy. So greatly does the use of 
money facilitate the transfer, buying, and selling of private 
property, and so closely are property and pecuniary trade con- 
nected in practice and in the thoughts of men, that every rad- 
ical proposal or attempt to abolish private property, includ- 
ing the recent marvelous performance of the Bolsheviki in 
Eussia, has included a plan to do away with money also. But 
money and private property are not essentially and logically 
bound up together, for a certain measure of private property 
always has been found where money was little or not at all 
used. True, if there were absolutely no private property 
there would be little use for money, although it might still 
be used as a form of counter by the communistic state. We 
have already seen * how a monetary unit comes into use, 
and have treated of the nature of money. We note here that 
the use of money is an outstanding feature of the present 
economic system and gives rise to many of the problems of 
political economy. 

§ 10. The competitive system. The existing system is 
likewise characterized by competition ^ in the buying and sell- 
ing of wealth and of the usances and services of economic 
agents. By competition we mean here the condition of po- 
litical freedom on the part of each man to trade his property 
(goods, uses, or services) as he chooses, and this combined 
with the disposition on .his part to get what he values most 
highly for himself and his family. Whenever any one else 
(official or citizen) forbids and prevents a man from getting 
all he can, in so far competition is limited. Whenever any one 
is deterred by fear of, or by affection for, some other trader, 
from getting all he can, in so far competition is limited. 
Whenever any one conspires with another trader to act to- 

4 See Vol. I, p. 51, and above, eh. 2. 

5 See Vol. I, p. 73. 



Ch. 32] THE PRESENT ECONOMIC SYSTEM 553 

gether with him to withdraw or to alter his bid, in so far com- 
petition is limited. Private propertj' and economic competi- 
tion do not merely happen to exist side by side, forming more 
or less favored conditions each for the other; they are essen- 
tially connected.^ 

It is not our task at this point to present the advantages 
and disadvantages of competition, but merelj'^ to indicate its 
important place in the actual economic world. Like private 
property, competition is not a universal feature of our pres- 
ent system, but it is the most general and characteristic 
method of valuation, of price-fixing, and of trade. 

§ 11. Limitation of competition by custom." The rela- 
tively large influence of competition in present society ap- 
pears more plainly in comparing the present system with that 
of an earlier state of society or with that of a present savage 
tribe. A member of the lowest human societies is subject to 
law; though he is a savage, he is not "untutored."" On the 
contrary, he is bound in man}- ways to follow customary lines 
of conduct, and a large part of his time is given to learning 
the traditions and then to observing the ceremonials of the 
tribe. Primitive customs always take on a religious sanction, 
and every member of the tribe is piously bound to do as his 
fathers have done and as his neighbors are doing. This limi- 
tation applies to the choice of food to eat, clothes to wear, 
time to hunt, plant, and harvest, weapons and tools to use, 
where and how to trade, how much to give or take, and to 
countless other details of economic choice. So, in early 
society, economic relations were complex and but slowly 
changing from generation to generation. Custom, rather 
than competition, ruled in maniiold ways the economic actions 
of men. 

Custom continued to rule a large share of the individual life 

6 This will appear in oomparin<T the competitive methods of distribu- 
tion with other methods in ch. 34, §§ 7-11. 

"See Vol. I, p. 143, on medieval land tenures; p. 1.58, on customary 
rents; p. 190, on the pfiFect of caste. 



654 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

of the peoples of northern Europe through barbarian and 
feudal times. Its force has gradually decreased, but even 
yet is not entirely set aside. Political and economic interests 
were not clearly distinct in the Middle Ages. Land was the 
all-important kind of wealth. Military and other public serv- 
ices were performed by the higher landlords (as vassals of 
their overlords) , who in this way paid at the same time what 
we to-day would call rent and taxes. The landlord in turn 
received from his underlings services and goods in kind (food 
and supplies) and so (in modem eyes) was both a collector 
of taxes and a receiver of rent. The rent, however, was not 
a competitive price, but consisted of the dues and services 
that the forefathers had been accustomed to pay. In many 
ways also, in the towns, close organizations of craftsmen and 
of merchants regulated prices and kept others out of their 
industries. Industrial privilege pervaded the life of that 
time. 

Yet through all the Middle Ages ran the forces of competi- 
tion. The inefficiency of customary services and the high 
prices charged by selfish privilege were constant invitations 
to men to become competitors. Men strove to break over the 
barriers of custom and of prejudice. The effort to a^ttain 
freedom to compete was the vital force of the time. The in- 
dustrial history of the Middle Ages was largely the story of 
the struggle of the forces of competition against the bonds of 
custom and privilege. 

§ 12. Effect of modern forces upon custom. The in- 
dustrial events following the discovery of America strength- 
ened the forces making for economic freedom. Discoveries in 
the western hemisphere opened up a wide field for the ad- 
venture and enterprise of Europe. Commerce is the strong- 
est enemy of custom, and new opportunities gave a rude 
shock to the conservatism both of the manor and of the vil- 
lage. With the rapid growth of industry and manufactures, 
old methods broke down. In an open market custom declines ; 
it flourishes best in sheltered places. Further, the movement 



Ch. 32] THE PRESENT ECONOMIC SYSTEM 555 

of thought in the Reformation, and the spirit of the times 
which expressed the principle of personal liberty and allowed 
the individual to follow his own opinions and take the con- 
sequences, were favorable to competition. Despite these 
facts, the restraints of the national governments on trade con- 
tinued great, in some respects increasing during the seven- 
teenth and eighteenth centuries in France, Holland, and Eng- 
land. The regulation before attempted by towns and vil- 
lages was employed on a larger scale by national governments 
in their industrial systems. The colonies in America were 
used for the economic ends of the "mother countrj'^" and for 
the selfish interests of the home merchants in Europe. The 
American Revolution was one of the bitter fruits of the Eng- 
lish policy of trade restriction. 

§13. Adam Smith's influence. "The Wealth of Na- 
tions," the first great work on political economy, was pub- 
lished in the year 1776. That was the "psj'chological mo- 
ment" for its appearance, as public thought was so prepared 
for it that it had its maximum possible influence. The year 
of the American Declaration of Independence gave the most 
striking object lesson on the evils of a selfish colonial policy 
that interfered on a grand scale with economic freedom. The 
old customs had become ill fitted to life, ill adapted to the rapid 
industrial changes that were going on. What was needed in 
many directions, both in politics and in industry, was merely 
negative action by the government, the repeal of the old laws, 
the overthrow of old abuses. The French Revolution, follow- 
ing a few years later, emphasized this thought in the political 
field. The philosophers of the time believed in a "natural 
law" in industry and politics. The reformers of the time 
wished to throw off the trammels of the past and to give men 
opportunity to exert them.selves "naturally." In America 
the old abuses never had taken deep root, as the conditions of 
a new continent were not favorable to monopoly and privilege. 
Although the movement for the repeal of medieval laws has 
continued in Europe from 1776 till the present time, yet cus- 



656 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

torn still is stronger to-day in Europe than in America. Serf- 
dom was not abolished until the first half of the nineteenth 
century in Austria and southeastern Europe, and not until the 
last half in Russia. Many economic and cultural forces fur- 
thered this movement, but the most powerful intellectual force 
in its favor was the work of Adam Smith. So strong an im- 
pression did Smith's book make that in the minds of men 
"free trade" became almost identical in thought with political 
economy, whereas that was but the temporary economic prob- 
lem of the eighteenth century. 

Many men then thought that in "free and unlimited com- 
petition" had been found a solution of all economic problems 
for all time. But soon it was apparent that it was no such 
simple and absolute solution. Indeed, many of the present 
economic problems — in one sense all of them — center around 
this one: to determine the proper forms and limits of com- 
petition. This problem has appeared in various aspects 
throughout the foregoing pages. 

§ 14. The wage system. Viewed in another aspect, the 
present economic and social order is called the wage system.^ 
The wage contract, like the use of money, is not essential to 
the existence of a system of private property. Communities 
such as the American colonies and many of the newly set- 
tled states may consist almost entirely of self-employed own- 
ers of land. Bulgaria, before the Balkan wars called the 
peasant state, presented this organization (though of course 
with some wage payment), as did also its neighbor Serbia. 
But, given the institution of private property with competition 
(freedom to buy and sell), let manufactures and commerce 
develop to any extent, and inequalities of fortunes increase 
while an increasing number of persons work for wages. It is 
noteworthy that as this goes on (as it has done in America at 
an increasing rate since the middle of the nineteenth century) 
it is the agricultural and rural hand industries that continue 
to be mainly worked by owner-managers and workers, while it 
8 See Vol. I, p. 227, and above, ch. 20, §§ 1-4. 



Cii. 32] THE PRESENT ECONOMIC SYSTEM 557 

is the manufacturing, transporting, and large commercial en- 
terprises in which the labor is done for wages. The accept- 
ance of the wage system thus far has been the inevitable price 
to be paid for manufacturing and industrial development. 

Refeeexces. 

Brooks. J. (1.. Labor's cliallenge to the social order. Pp. 441. New 
York. Macmillan. 1920. An able description and analysis of 
the aims and accomplishments of the different labor groups. 

Cooley, C H., Human nature and the social order. N. Y. Scrib- 
ner. 1902. 

Ell/, R. T., Competition: its nature, its permanency, and its benefi- 
cence. A. E. Assn. Pubs., 3d ser.. 2; 55-70. 1901. 

Ell/. R. T., Property and contract in their relation to the distribu- 
tion of wealth. N. Y. Macmillan. 1914. (2 vols.) 

Gladden. Washinglon, Tools and the man. N. Y. Houghton. 1893. 
(One example of a large numljer of American books appealing for 
the application of Giristian ethics to social questions.) 

Gleason, A.. What the workers want. A study of British labor. 
Pp. 518. New York. Harcourt, Brace and Howe. 1920. 

King, W. I., The wealth and income of the people of the U. S. New 
York. Macmillan. 915. 

Xation^il Bureau of Euonomic Research, The income oi the U. S. 
New York. Harcourt, Brace & Co. 1921. 

J'arker, C. The casual laborer and other essays. Pp. 199. New 
York. Harcourt, Brace & Howe. 1920. Study of the psychology 
of the laboring element that makes up the bulk of the 1. W. W. 

8pa.hr, C. B., Present distribution of wealtli in the United States. 
1896. 

Watkins, G. P., Growth of large fortunes. N. Y. Macmillan. 1907. 

Williams, W., ^^^llat"s on the worker's mind? N. Y. Scribner. 
1920. A first hand study of the problem of industrial unrest. 



CHAPTER 33 
PUBLIC OWNERSHIP 



§ 1. Waves of opinion as to public ownership. § 2. Primary function.^ 
of government favoring public ownership. § 3. Economic influences fav- 
oring public ownership. § 4. Forms of municipal ownership. § 5. Local- 
ized production favoring monopoly. § 6. Economies of large produc- 
tion favoring monopoly. § 7. Uniformity of products favoring monopoly. 
§ S. Franchises favoring monopoly. § 9. Various policies toward local 
public service industries. § 10. State ownership of various kinds. §11. 
National ownership. § 12. Economic basis of public ownership. § 13. 
Sources of heat, light, and power. 

§ 1. Waves of opinion as to public ownership. Opinion 
and practice in the matter of the public ownership of wealth 
and the direct management of enterprises has moved in 
waves. In feudal times, when government was virtually 
identical with the personal ruler, and the private "domains" 
of the lord or king were the sole source of his public reve- 
nues,^ holdings of this kind were very large. Their public 
nature came to be more fully recognized, but they did not 
yield large revenues, and gradually were in large part sold 
or given away to private owners. This was particularly true 
in England, and in a less degree on the continent of Europe. 
The conviction grew that the state, or government, was an in- 
efficient enterpriser, and that the sound public policy was 
to foster private industry and obtain public revenues by tax- 
ation. The ideal was embodied in the laissez-faire philosophy 
that government should confine itself exclusively to the most 
essential political functions, leaving the economic functions 
absolutely alone. It should keep the peace, prevent men from 

I See above, ch. 17, § 5. 

558 



Ch. 33] PUBLIC OWNERSHIP 550 

beating and robbing each other, and preserve the personal 
libertj^ of the citizen.^ Thus, it was believed, all of the eco- 
nomic needs would be provided for by competition, in the best 
way humanly possible, in the quantities and at the rate needed. 
This policy attained its maximum influence in the first half 
of the nineteenth century in England, and in America prob- 
ably just before the Civil War, in the decade of the fifties. 

§ 2. Primary functions of government favoring public 
ownership. Civilized government requires the use of numer- 
out material agents to make possible the exercise even of 
the primary political functions. The state may either own 
these agents or hire their use from private citizens who own 
them. It is now the general policy for government to own 
and control many of the more essential agencies, especially 
for the performance of the political functions; but a wide 
range of choice remains. Buildings for legislative and ex- 
ecutive officers, customs-houses, post-offices, lighthouses, can be 
rented from private citizens, as post-offices usually are in 
small places ; but it is obviously economical and convenient 
in large cities for the government to own the public buildings. 

A city maj' o\m the machines and wagons for cleaning 
the streets and for collecting garbage, and may hire day- 
labor directly, or it may have the work done by private con- 
tractors. The more simple political functions shade off into 
the economic. To coinage usually' are added the issue of 
legal-tender notes and certain banking functions; the post 
carries packages, transmits money, and in most countries now 
performs the function of a savings bank for small amounts. 
The social and industrial functions undertaken by public 
agencies have steadily increased since the middle of the nine- 
teenth century, and the sphere of the state has been enlarg- 
ing.^ The question as to the proper limits to this develop- 
ment is ever open. 

§ 3. Economic influences favoring public ownership. 

2 See ch. 17, § 2, on the police function. 

3 See ch. 17, § 3 and § 4. 



5G0 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

In some cases private ownership is difficult because of the 
excessive cost of collecting for the service. The cost of main- 
taining toll-houses on a turnpike sometimes exceeds the 
amount collected. Collection in other cases, as for the serv- 
ice of lighthouses to passing ships, is impossible. Public in- 
dustry may secure, through the economy of large production, 
a cheaper and more efficient service, the benefits and costs 
being diffused throughout the community. A manufacturer 
able to keep his methods secret, or to retain his advantages 
for a time, can afford to undertake expensive experiments 
in his business, but the farmers seldom can. The benefits of 
the work of experiment stations for agriculture are felt im- 
mediately by the farmers, but are diffused to all citizens. The 
public ownership of parks for the use of all gives a maximum 
of economy in the production of the most essential goods, — 
fresh air, sunshine, natural beauty, and playgrounds in the 
midst of crowded populations. Municipal ownership of water- 
works is an extension of the same idea. Not only because large 
amounts of water are used by the public, but because cheap, 
pure, abundant w^ater is an essential condition to good citi- 
zenship, it is felt that speculation should in every possible 
way be eliminated from this industry. 

The assumption is made in the laissez-faire doctrine that 
the interest of the public harmonizes with that of the individ- 
ual. But this proves often not to be the case. For example, 
the forest has an immediate value to its owners and to the 
consumers of lumber, and it has also a diffused utility in its 
influence on industry, on , climate, on navigation, on water- 
pciwer, and on floods. Yet, as the private owner, unless a 
great land monopolist, does not control enough of the forest 
appreciably to affect any of these things, and could rarely 
sell them even if he could affect them, he will cut down the 
tree whenever he can gain by doing so. In this situation 
either governmental control or governmental ownership of 
forests is essential. 

Each kind of political unit, or subdivision of government, 



Ch. 33] PUBLIC OWNERSHIP 5G1 

develops characteristic kinds of public ownership and indus- 
try. Federal states consist of three main groups of political 
units; national, provincial, and local. Proviyicial units are 
the largest subdivisions, as the American "states," or com- 
monwealths, the German states, and the provinces in other 
countries. The term local poliii-cal unit is more complex, and 
may mean county, township, village, city, or school or sani- 
tary district; but most of what is to be said of local owner- 
ship refers to cities or to incorporated villages. 

§ 4. Forms of municipal ownership. Local political units 
acquire ownership only in local industries and in wealth used 
locally b}' the citizens. Nearly all parks and recreation- 
grounds are owned by cities. As population has become more 
dense, private yards of any extent have become impossible, 
in cities, for all but the wealthy. Public ownership of parks 
insures a "l)reathing-place" and recreation-grounds to the 
common man in the most economical way. Of late the move- 
ment for large and small public parks and playgrounds has 
gone on rapidly in American cities. Related to parks are 
public baths, public libraries, art collections, museums, zo- 
ological gardens, etc. Some have seen danger in this policy 
of "giving something for nothing," but the public sees no 
such danger as long as the things supplied gratify the higher 
tastes — as art, mu.sic, literature, and social recreation. These 
give no encouragement to the increase of improvident families 
and to the breaking down of independent character. 

Streets, roads, and bridges were once owned largely by pri- 
vate citizens. Here and there still are found toll roads and 
toll bridges built under charters granted a century ago, but 
tolls on public thoroughfares are for the most part abolished. 
Public markets, where the producer from the farm and the 
city consumer can meet, are old institutions. About two 
thirds of the cities of 30,000 population or more have public 
markets or scales, and fully one third have public markets of 
importance. New York city has six large retail and whole- 
sale markets for selling meat and farm produce, in which 



562 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

rents or fees are charged, and several open markets. There 
has recently been a large movement in this direction. 

The providing of apparatus for extinguishing fires is al- 
ways a public duty; the conveyance of waste water is in- 
creasingly a public function. The supply of pure water for 
domestic and business uses, for fire protection, and for street 
cleaning, while often a private enterprise in villages and 
sometimes in large cities, is increasingly undertaken by pub- 
lic agencies. Most of the larger cities now own their own 
water-supply systems. Public ownership of gas and electric 
lighting is less common, as the utility supplied is not so essen- 
tial and the industry is somewhat less subject to monopoly; 
but the difference is one of degree only. Street railroads are 
often under public ownership in Europe ; but there have thus 
far been few eases of the kind in the United States and Can- 
ada.* 

§ 5. Localized production favoring monopoly. A num- 
ber of these enterprises have characteristics in common which 
appear to make inevitable their drift into monopolistic con- 
trol. Waterworks, gas, electric lighting, street railways, tele- 
phone systems, are among these. However fierce may be the 
competition between separate private companies for a time, 
sooner or later either one company drives out the other or 
buys it up, or both come to an agreement by which the public 
is made to pay higher prices. 

A feature favoring the growth of monopoly when such in- 
dustries are left to private enterprise is the need to produce 
and supply the commodity or service at a given locality. 
While two street railways can compete on neighboring streets, 
it is physically impossible for two or more to compete on the 
same street. Two systems of water-mains or gas-mains can 
be put down, as sometimes is done ; but this is not only a great 
economic waste, but the tearing up of the streets is an intol- 
erable public nuisance. This difficulty is less marked in the 
case of telephones and electric lighting, and some persons still 
cling to faith in competition to regulate the rates in those in- 

4 See ch. 17. § 5, industrial revenues of governments, 



Cii. 33] PUBLIC OWNERSHIP 563 

dustries; but faith in competition between water companies 
and between; gas companies has been given up by nearly 
all persons now, as it was long since by students of the sub- 
ject. 

§ 6. Economies of large production favoring monopoly. 
A second feature favoring monopoly in such industries is the 
marked advantage of large production in them. These indus- 
tries are usually spoken of as "industries of increasing re- 
turns." This advantage is enjoyed in some degree by every 
enterprise, but it is gradually neutralized and limited. The 
need to extend an expensive physical plant to every point 
where customers are to be served, and the very much smaller 
cost per unit of delivering on the same street large rather than 
small amounts of water, gas, electricity, and transportation, 
offers a greater inducement for one competitor to crowd out or 
buy out the other at a more than liberal price. Even then, 
larger net dividends and correspondingly larger capitalization 
are secured than were before possible to both companies com- 
bined. 

§ 7. Uniformity of products favoring monopoly. A 
third feature favoring monopoly is uniformity in the quality 
of the product furnished. It is a general truth that compe- 
tition is most persistent where there is the greatest range of 
choice open to the customer, and consequently the most indi- 
vidual treatment required of the enterpriser. An artist's 
product is very distinctive. Even a storekeeper attracts 
about him a body of patrons who like his product (for the 
merchant's manner and method of dealing are qualities of 
his goods) and who cannot be tempted av/ay by slight differ- 
ences in price. Rival companies in the stage of competition 
are seen to claim superiority for their particular goods and 
to improve their service in every way possible. A new 
telephone company, entering where a monopoly has held 
the field, works at once a wonderful betterment in rates, 
courtesy, and service. But, as the product of all competitors 
attains the highest technical standard possible at the time, 



564 PEIVATE PROPERTY VS. SOCIALISM [Pt. VI 

the rivalry is reduced to one of price, and it is usually a 
"fight to the finish." 

§ 8. Franchises favoring monopoly. A fourth feature 
favoring monopoly in these enterprises is the necessity of 
making permanent and exceptional use of the public streets 
and alleys. If this right were granted by a general law to 
every citizen, this feature would be sufficiently implied in the 
foregoing discussion. As it would be intolerable to allow 
private interests to use public property in whatever way they 
wished, the legislative body makes special grants in such cases, 
in view of the circumstances. Not only is the legislature (or 
council, or county board of commissioners, etc.) led by the 
economic difficulties to withhold a charter from a second 
company, but it may be corruptly influenced by the company 
already established. The knowledge of the opposition to be 
encountered in getting a franchise must keep competitors out, 
even though monopoly prices are maintained. 

Because of these several features, which are so closej^y re- 
lated that they form a common character, more or less fully 
shared by various industries, and especially in view of the 
necessity for the formal granting to them of peculiar priv- 
ileges in the form of a public franchise, they are monopolies. 
The public, in order to protect itself, is forced to undertake an 
exceptional control of these industries. 

§ 9. Various policies toward local public-service indus- 
tries. Several courses are open to the public, acting in its 
political capacity, to retain these monopolistic advantages for 
the general welfare, (a). It may do nothing, trusting vainly 
to competition to regulate the rate, or consciously leaving the 
result to be worked out by the monopoly principle ; this is 
what in most cases has been done in the past in America, 
(b) It may leave the rate to be fixed by the monopoly prin- 
ciple, but charge for the franchise so much that the value 
of the monopoly is appropriated into the public treasury; 
virtually this is selling the franchise at auction, (e) It may 
attempt, in granting the franchise, to fix near cost the 



Cii. 33] PUBLIC OWNERSHIP 505 

charge for the service or product, so that the franchise will 
be worth little as private property, (d) It may leave the 
price to be fixed at cost, not definitely by law, but by an 
administrative commission having the power to regulate 
rates, (e)) It may have public officials carry on the busi- 
ness, either selling the product at cost or making monopoly 
profits that go into the public treasur}-. Various combina- 
tions of these plans are followed in practice. 

After plan (a), rates fixed in the franchise (c) had 
wide vogue. But fixed maximum rates, even under the most 
favorable conditions, are rarely equitable, for a uniform rate 
does not apply justly to all parts of a town and to all con- 
ditions of service. Fixed maximum rates become too high 
in periods of stationary prices, when technical improvements 
are rapidly introduced, and from a different cause, when gen- 
eral prices are falling, as between 1873 and 1897. They be- 
came too low (unless offset by extraordinary technical im- 
provements and economies of increasing output) in periods 
of rising prices. Since the nineties many public utilities 
have been brought to the verge, or quite into, bankruptcy, 
w'hile many others have found their salvation in the admin- 
istrative commissions, which had the power to increase the 
rates as well as to reduce them. 

The plan of selling the franchise (b) is difficult to apply 
because of the limited number of bidders and because of the 
unpredictable character of the returns. There remain the 
policies of administrative rate-fixing (d) and of pul)lic owner- 
ship to secure the profits of monopoly to the public, either 
directly or in a diffused manner. In the recent period of 
rising prices the administrative state commissions have, like 
the Interstate Commerce Commission, performed very valu- 
able services. But, on the whole, the general trend of muni- 
cipal policy is everywhere toward public ownership of this 
type of local public-service industries. 

§ 10. State ownership of various kinds. The movement 
toward public ownership by the American states has been 



566 PRIVATE PROPEETY VS. SOCIALISM [Pt. VI 

much less marked than that by the municipalities. Many of 
the states have retired from some fiesMs where once they 
were engaged in industry. Students of American history 
know that between the years 1830 and 1840 some states en- 
gaged largely, even wildly, in canal-building, railroad con- 
struction, ]3anking, and in other enterprises. The undertak- 
ing of these industries was determined often by political and 
by selfish local interests, and their operation often was waste- 
ful. A few enterprises succeeded for a time, the most notable 
of these being the Erie Canal in New York, though this too be- 
came almost worthless as a result of railroad competition. The 
unsuccessful ones remained in the hands of the state or were 
sold to private companies, as in the case of the Pennsylvania 
Railroad. These reckless state enterprises were bitter lessons 
in public ownership, and continued for three quarters of a cen- 
tury to have such an effect on public opinion that few pro- 
posals for public ownership could have a fair hearing in 
America. But railroads and canals are publicly owned, and 
more or less successfully operated, by many foreign states, aa 
in Prussia and other German states, in Switzerland, and in 
the new states of Australia, and this policy is rapidly extend- 
ing to other countries and to varied industries. 

There has been recently a greatly increased interest in for- 
estry shown by the American states. This is especially likely 
to be a state enterprise wherever the forest tracts are entirely 
within the limits of the state, as in the case in New York 
with 2,000,000 acres and Pennsylvania with 1,000,000 acres 
of state forests. At present at least thirty-thi-ee states have 
forestry departments. Most of the forests in Germany are 
either communal or state-owned. The schools, a great in- 
dustry for turning out a product of public utility, are largely 
conducted by the American state and by local units rather 
than by the nation or by private enterprise. The state en- 
courages researches in the arts and sciences, and gives tech- 
nical training. A variety of minor enterprises have been 
undertaken by states to supply salt, phosphate, banking f aeili- 



Cii. 33] PUBLIC OWNERSHIP 567 

ties, even some manufactures. One after anotlier the states 
are adopting the ''state use" system of labor in the prisons 
and public institutions, engaging in agriculture and manu- 
facturing on a large scale, and using the products, amount- 
ing to millions of dollars annually, almost entirely for public 
purposes. 

§ 11. National ownership. The national governments ev- 
erywhere appear to be enlarging the field of their ownership, 
This policy has its roots far in the past. Some industries grow 
out of the political needs of government. Established as a 
means of communication with military outposts, the post be- 
came a convenient means of communication for merchants and 
other citizens and grew into a great economic institution. In 
most countries the telegraph is publicly owned and has been 
annexed to the post, to which it is very closely related in pur- 
pose. National ownership of railroads is the rule, and our 
policy of private ownership the great exception in the world 
to-day. ]\Iany persons, some in railroad circles, have long 
believed that national ownership of railroads is sure to de- 
velop out of our present policy of regulation; and this 
opinion is gaining ground, since the passage of the Transpor- 
tation Act of 1920, even with many that deplore the prospect. 

The national improvements connected with rivers and har- 
bors were first political — that is, they were for the use of the 
government 's navy ; they became, secondly, commercial — for 
the free use of all citizens engaged in trade; and they con- 
tinue to unite these two characters. Forestry is most largely 
undertaken in this country by the national government, partly 
because some forest areas in the West extend over state 
boundaries, and largely because large tracts of public forest- 
lands were still unsold at the time public attention was at- 
tracted to the subject. Since 1890 the policy of reserving 
great areas for forests, and picturesque districts for national 
parks, has developed greatly in the United States. The na- 
tional forest area contained in the various forests in twenty 
states (not including Alaska and Porto Rico) now covers 



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Cji. 33] PUBLIC OWNERSHIP 569 

about 282,000, square miles, equal in area to six states of the 
size of Pennsylvania, with all of New Jersey, Delaware, and 
Rhode Island thrown in for good measure; or to all New Eng- 
land and the middle Atlantic states, plus Ohio, Indiana, and 
"West Virginia. There are, besides, fourteen large national 
parks, ranging in size from a few hundred acres up to 
over 2,140,000 acres (the area of the Yellowstone National 
Park), and aggregating 4,600,000 acres, nearly the size of 
Massachusetts or of New Jersey, besides numerous other na- 
tional reservations for monuments and antiquities. 

In some countries mines are thought to be peculiarly fitted 
for national ownership and control. In Germany the 
several states own coal, salt, and other mines. Coinage 
and banking are everywhere looked upon as functions of 
sovereignty, and yet it is no more necessary for a nation to 
own its own mint in order to control the monetary system 
than for it to print the bank-notes in order to regulate their 
issue. The American government has its own printing-office. 
The fish commission, and the various branches of the depart- 
ment, cooperate with private industry in many ways. This 
brief survey suggests that the industries undertaken by gov- 
ernment are botli varied in nature and large in extent, al- 
though small in proportion to the mass of private industry. 

§ 12. Sources of heat, light, and power. Next to the 
question as to tlie public ownership of the railroads, that as 
to coal mines and hydraulic power sites is most likely to be- 
come insistent for answer in America in the not distant 
future. The law of the conservation of energy expresses the 
fundamental likeness of heat, light, and power. The prin- 
cipal sources from which man derives these agencies are 
coal and falling waters, though wood is of importance as fuel 
in some localities. About 500,000 square miles of land (about 
13 per cent of the area of the country) are underlaid with 
coal. These deposits are widely distributed, so that nearly 
ever\- part of the country is within five hundred miles of a 
mine. The enormous deposits, if used at the present amounts 



570 



PRIVATE PROPERTY VS. SOCIALISM 



[Pt. VI 



per year, would last probably from two to four thousand years, 
but if used at the present increasing rate (doubling the prod- 
uct every ten years), they would, it has been estimated, last 
but one hundred and fifty years. What shall be the actual rate 
as between these extremes is a question the answer of which 
depends on our economic legislation as to ownership, exploi- 
tation, prices, use, and substitution. The experiences in the 
war, as well as the constantly recurring labor difficulties in 




Fig. 2, Chapter 33.— Coal Fields of the U. S. 



coal-mining, verging upon civil war, have forced the public 
thought to recognize its ' dependence on the regular supply 
of coal, a,nd the exceptional public nature of the coal industry. 
The one great available substitute for coal as a source of 
heat and light and power is water-power. It is estimated 
that in 1908 but 5,4:00,000 horse-power was being developed 
from waterfalls, whereas about 37,000,000 primary horse- 
power ^ was available ; but, by the storage of flood-waters so 

5 That is, "the amount which can be developed upon the basis of 
the flowage of the streams for a period of two weeks in which the flow 



t'lr- 33] PUBLIC OWNERSHIP 



571 



as to equalize the flow, at least 100,000,000 horse-power, and 
possibly double that amount, could be developed. As it re- 
quires ten tons of coal to develop one horse-power a year in 
a steam-engine by present methods, there is here a potential 
substitute for coal equal to from two to four times our 
annual use of coal (above 600,000,000 tons). 

But this does not mean that it would be economical, at 
present costs of mining coal and of building reservoirs, to 
make this substitution now. To determine when, how far, 
and by what methods to develop this water-power from lakes 
and rivers for the use of the people, and to make this sub- 
stitution, is one of our great economic problems. The ques- 
tion is being daily decided, in numerous acts of legislation and 
administration, whether the water-power of the United States 
shall be more rapidly developed by becoming private prop- 
erty, or shall be developed more slowly as a part of the na- 
tional domain. 

§ 13. Economic basis of public ownership. The question 
as to the proper limits of public ownership is one most ac- 
tively debated. The movement is progressing in accordance 
with the principle that public ownership is economically jus- 
tified wherever it secures a product or service of widespread 
use that would otherwise be impossible, or insures the public 
a better quality or a lower price. The question of public 
ownership is not exclusively an economic question. There 
are incidental problems, such as its effects on enterprise and 
on political integrity, with which it is not possible here to 
deal. In the main, however, public ownership is simply a 
business policy which must be justified by its economic re- 
sults. In the case of a general social benefit not to be secured 
without public ownership (as popular education or the cli- 
matie effect of forests), the only question to answer is whether 
the utility is worth the cost. In the case of industries already 
in private hands, as waterworks, gas and electric lighting, 

is the least," all the rest being allowed to oscape unused. Van Hise, 
"Conservation of Natural Resources,'" p. 119. 



572 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

there is needed, to make a wise decision possible, a knowledge 
of the effect a change to public ownership will have upon cost 
and service. If public officials can furnish some goods more 
cheaply than they are furnished by private enterprise, it is be- 
cause of the wide margin of monopoly profit, not because there 
is any magic in public ownership. The same general items of 
cost must be met. The first cost of the plant and the annual 
interest payments are much the same. Experience shows 
that, because of political influence and of public opinion, wages 
are likely to be higher under public ownership, but salaries for 
management lower. Public collection of dues along with 
taxes is an advantage not enjoyed by private companies. Sev- 
eral public officials sometimes share the same office and thus 
reduce expenses. In small towns the public electric lighting 
and waterworks have been operated more economically under 
one roof. Some items of cost may be less under public man- 
agement, but, on the whole, public industry probably has no 
advantage in these respects. Public industry does not have 
to meet the costs of lobbying and blackmail which are often 
forced upon private companies. But the greatest source of 
saving in public ownership is the value of monopoly privi- 
leges that, under private management, go into private pockets. 

The temptation of political corruption may be more insist- 
ent when a large force of men is constantly employed, and 
when large supplies are constantly purchased, by public offi- 
cials, but the temptation is not so strong or so centralized as 
it is in the granting of franchises to wealthy corporations. 
Public industry is weakened by the absence of certain motives 
to excellence that are present in private business. The income 
of public officials not being dependent on the economy of 
management, the spur and motives of competitive industry 
are lacking. No social discovery has made individual hon- 
esty and civic virtue useless to good government. 

The decision in any specific case is one dependent on local 
conditions, and the exact limits of public ownership are not 
fixed. Industry is changing so rapidly that new adjustments 



Ch. 33] PUBLIC OWNERSHIP 673 

are made every year. The main outlines of public ownership, 
however, are now in large part determined. Some industries 
do well, others ill, under public management, and between 
these lie many debatable cases. Waterworks and probably 
electric lighting, because of the comparative simplicity of 
their operation, are more suitable for public ownership than 
are gas-works. No absolute line divides the one group from 
the other. But, whatever the changes, the fact cannot be 
ignored that the increase of public ownership is altering in 
manifold ways the organization of industry, and is reacting 
upon the production of wealth and the distribution of in- 
comes. 

References. 

Bemis, E. W., (Ed-), Municipal monopolies. N. Y. Crowell. 1899. 

Brooks, R. C, Municipal Affairs, 5: 1-346. 1901. An exhaustive 
and well-arranged bibliography on all aspects of municipal prob- 
lems. ) 

Fairlie, J. A., Recent extensions of municipal functions, in the United 
States. A. A. A., 25: 299-310. 1905. 

Guyot, Yves, Where and why public ownership has failed. Trans. 
19: 61-73. 1902. 

Lincoln, E. E., The results of municipal electric lighting in Massa- 
chusetts. Pp. 484. Roston. Hougliton, Mifflin Co. 1918. 

Maltbie, M. It., Municipjvl utilities. Princeton. University Press. 
1917. 

National Civic Federation, Report on municipal and private opera- 
tion of public utilities. 1907. 3 vols. (A monumental study by 
an American delegation, which visited many cities of Europe and 
America; favorable, in the main, to extension of municipal owner- 
ship. ) 

Stephens I. />.. A bibliography of municipal utility regulation 
and munici|)al ownership. Pp. 410. Cambridge. Harvard Univ. 
Press. 1918. 

Todd, A. M., Municipal ownership, with a special survey of municipal 
gas plants in America and Europo. Public Ownership League 
of America. Chic. 1918. 

Van Hise, C. R., Conservation of natural resources. N. Y. Mac- 
millan. 1910. 



CHAPTER 34 



METHODS OF DISTEIBUTION 



§ 1. The problem of distribution. § 2. Distribution by foi'ce and by 
status. §3. Social effects of the right to transmit property. §4. Ef- 
fects of the right to inherit property. § 5. Broader social effects of in- 
heritance. § 6. Limitations upon intestate inheritance. § 7. Some 
merits of competition. § 8. Wide acceptance of competition. § 9. "Eco- 
nomic harmonies" and discords. § 10. Competition modified by charita- 
ble distribution. § 11. Competition modified by authoritative distribu- 
tion. § 12. Progressive versus reactionary. § 13. Progressive versus 
radical. 

§ 1. The problem of distribution. The great economic 
progress of the past two centuries has been mainly in lines of 
technical production. The developing natural sciences and 
mechanic arts have given men a marvelously increased control 
over forces and materials. This has multiplied the quantities 
of goods of most kinds at the disposal of men, collectively con- 
sidered. All men, with rare exceptions, have been gainers; 
but the increased production has been very unequally dis- 
tributed among the members of the community. More and 
more insistently the plea and the demand have been made for 
better methods of distribution that will give to the masses of 
the people a larger share of the goods produced. Production 
is largely a problem of the technical arts; distribution is a 
problem of social economy. Distribution as a problem of in- 
comes is not to be confused with distribution of physical goods 
by transportation (as on the railroads) or by commercial 
agencies transferring goods from producer to consumer (as 
ai cooperative stores and marketing). 

Two aspects of the distribution of incomes may be distin- 

574 



Ch. 34] METHODS OF DISTRIBUTION 575 

guished. Functional distribution is the attribution of value 
(yields) to wealth and labor considered impersonally, as 
groups of productive agents. Functional distribution is the 
prime subject of the theory- of value and price ^ (e. g., usance, 
value of labor, time preference, profits), a study of which is 
prerequisite to an intelligent study of the problems of per- 
sonal distribution. 

Personal distribution is the actual movement of incomes 
into the control of persons. Personal incomes, whether 
monetary, real, or psychic, are the sum of a number of 
elements. Some parts are due to services performed by the 
person himself. When one combs his own hair he is per- 
forming for himself a service that is a part of his income. 
Benjamin Franklin said it was better to teach a boy to 
shave himself than to give him a thousand dollars with 
which to pay barbers for a life-time. Other parts of income 
are the uses and fruits of legally controlled wealth ; chance 
finds, as gifts of value or lost and abandoned goods ; goods as- 
signed to one by authority ; wealth inherited ; illegal gains by 
robbery; goods secured on credit; gifts either of things or of 
services. The many methods by which incomes are distributed 
to the persons making up a society may be grouped in the fol- 
lowing five general classes: (1) force, (2) status, (3) charity, 
(4) competition, and (5) authority. These will be discussed 
in order. 

§ 2. Distribution by force and by status. Distribution 
by force is the most primitive mode of distribution. The 
stronger takes from the weaker. Slavery is distribution by 
force, as is the levying of war indemnities from a conquered 
people. Forceful distribution still persists in the form of 
crime, and, if we include fraud within the term, it still affects 
an enormous amount of income. The lawless take whatever 
they can, and the supporters and officers of the law do what 
they can to check the acts. 

Distribution may be by status, or set rules and customs. In 

1 Treated throupliout Vol. I. 



576 PRIVATE PROPERTY VS. SOCIALISM [Pr. VI 

this case men receive incomes that are independent of their 
efforts and outside of their control. Distribution by status is 
guided neither by the personal merit of the recipients nor by 
the value of their direct services, but by the merits and acts of 
men not living. Feudal society was built on status. Men 
were born to certain privileges and positions; they inherited 
property which could neither be bought nor sold; they fol- 
lowed trades which could rarely be entered by any outside of 
favored families. Caste in India and in other Oriental coun-^ 
tries regulates a large part of the life of the people. 

This method still prevails to a greater extent in our society 
jhan is usually recognized.^ By public opinion and by preju- 
dice, status is still maintained in respect to the choice of occu- 
pations even where the law has formally abolished it, as is seen 
in modern race problems. In western countries to-day in- 
heritance of property is the main legal form of status and it 
shades off into other forms of distribution. Private property 
must find its justification in social expediency.^ There is no 
feature of it that is more questioned than is the right of in- 
heritance. 

§ 3. Social effects of the right to transmit property. 
The right to transmit property by inheritance or by bequest 
may be judged with reference to its effects upon the giver, 
upon the receiver, and upon society at large. It is well to 
take these three points of view. The right to dispose of prop- 
erty either during life or at death has undoubtedly in many 
ways a good effect upon the character of men. It stimulates 
the husband and father to provide for his wife and children, 
and spurs others to continued economic activity. There is a 
joy in giving, a joy in the power to bestow one's wealth upon 
those one loves, or as one pleases. Much of the existing 

2 See Vol. I, pp. 190, 223; and above, ch. 32, §§ 11-13. 

3 See Vol. I, pp. 248-255, 297, 298, 406, 408, 415-418, 480, 481, 483, 
484; also Vol. II, chs, 11, 20, and various passages in the chapters of 
*>iw Part. 



Ch. 34] METHODS OF DISTRIBUTION 577 

wealth probabl}' never would have been created if men had not 
had this right. But there is a limit to the working of this 
motive, and other motives often are more effective. Many a 
man after gaining a competence continues to work for love of 
wealth and power in his own lifetime, as the miser continues 
to toil for love of gold. When men without families die 
wealthy, when men not having the slightest interest in their 
nearest relatives labor till their dying days to amass wealth, 
it is apparent that the right to bequeath property has little to 
do with their efforts. Love of accumulation and love of power 
in these cases supply the motive. A more limited liberty to 
dispose of property at death might still suffice, therefore, to 
call out the greater part of. the efforts now made to accumulate 
property. 

§ 4. Effects of the right to inherit property. That the 
effects upon the receiver of the property are good is somewhat 
more doubtful. It is true that children reared in families of 
large incomes would be great sufferers if plunged into pov- 
erty at the death of their parents. There is much social justi- 
fication for permitting families to maintain an accustomed 
standard of comfort. Few would denj^ that provision by par- 
ents to provide education and opportunity for their children is 
commendable and desirable. But the evil effects of waiting 
for dead men's shoes are proverbial. i\Iany a boy's greatest 
curse has been his father's fortune. ]\Iany a man of native 
ability waits idly for fortune to come and lets opportunities 
for self-help slip by unheeded. The world often exclaims over 
the failure of the sons of noted men to achieve great things, 
for, despite confusing evidence, men still have faith in 
biologic heredity. A too easy fortune saps ambition and re- 
laxes energy; and thus rich men's sons, if not most carefully 
and wisely trained, are often made paupers in spirit, while 
the self-made fathers think their boys have better opportuni- 
ties than they themselves enjoyed. The greater social loss is 
not the dissipated fortunes, but the ruined characters. An- 



578 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

drew Carnegie said that it would be a good thing if every 
boy had to start in poverty and make his own way. Cecil 
Rhodes recorded in his will his contempt for the idle ex- 
pectant heir. 

§ 5. Broader social effects of inheritance. Inheritance 
'.^as good effects for the community in so far as it helps to secure 
efficient management of wealth. If the son or relative has 
been in business with the deceased, there is a reason why he 
should inherit the property, and his succession to it makes the 
least disturbance to existing business conditions. This con- 
sideration, however, has less weight as the corporate form of 
organization becomes well-nigh universal in "big business," 
Every profligate son, every incompetent heir, is an argument 
against the inheritance of property. It is to society's inter- 
est that no able-bodied member should stand idle. Every 
child should have presented to him the motive to use his 
powers in useful ways. Moreover, many feel that the great 
fortunes now accumulating through successive generations in 
the hands of a few families are a danger to our free society, 
even if these fortunes should continue to be well administered. 
There is a widespread feeling that the heredity of great wealth 
is, like the heredity of political power, out of harmony with 
the democratic spirit. Democracy wishes to see men and in- 
dividuals put to the test, not profiting forever by the deeds of 
their forebears. This feeling is shared by those who cannot 
be charged with radical prejudices. It was startling when a 
conservative body of lawyers, meeting in their state associa- 
tion in Illinois, passed a resolution favoring moderate limits 
to inherited fortunes. Almost every year sees bills of this pur- 
port introduced in the legislatures and in Congress. Prob- 
ably no one of many current radical proposals is more widely 
favored than this among men of otherwise conservative social 
views. The sum most often mentioned as the proper limit is 
$1,000,000, but usually it is a sum larger than the for- 
tune of the person speaking.* 

4 See ch. 32, § 7, on limitations upon bequest and inlieritance. 



Ch. 34] 3IETH0DS OF DISTRIBUTION 570 

§ 6. Limitations upon intestate inheritance. A proposal 
less crude, and with strong reasons of social expediency in its 
favor, is to limit the right of intestate inheritance to persons 
that have been in essential economic and social relations with 
the deceased. The foregoing considerations show that the case 
for the right of gift in the lifetime of the giver is strongest; 
that for the right of bequest comes next. The man who has 
acquired wealth may usually be trusted to decide who bear 
to him close social or personal relations, and to say whose lives 
have in a measure furnished the motives of his activity. But 
the right of intestate inheritance by distant relatives is one 
that stands on weak social foundations. It is a survival from 
more patriarehial conditions when, in the large family or clan, 
the bond of unity was very strong. A truer test to-day of the 
proper limits for intestate inheritance is whether the wish to 
provide for these heirs has furnished the motive for the pro- 
ducing and preserving of the wealth. The claims of those 
nearest in blood and closest in personal relations are strongest. 
Family affection and friendship form the strongest of social 
ties, and it is socially expedient to cultivate them. Motives 
for abstinence and industry must be strengthened. But the 
same test shows that the zealous regard of the American law 
for the rights of distant kinsmen in foreign lands or in dis- 
tant quarters of this country is irrational, and is unjust to the 
community where the fortune was made. Public opinion tends 
strongly toward this idea. 

Property rights as they exist are clearly seen not to be a 
product of pure reason. They are the result of social evolu- 
tion, of historical accidents, of class legislation, and in many 
cases of selfish interests. Chan<z-ing social conditions and 
ideas are bringing many changes in law, and further changes 
must be expected to come that will reduce the influence of 
inheritance of property in fostering status in distribution. 
Especially important are the increasing application of the pro- 
gressive principle to incomes and inheritance,* and the de- 

5 See ch. 19. 



580 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

velopment of insurance to put family savings into the form 
of terminable annuities instead of capital sums.^ 

§ 7. Some merits of competition. The dominant method 
of distribution to-day is that of competition/ It is evident 
from the voices of praise and of blame that competition has its 
good and its bad aspects. Let us observe first the good ones. 
Competition acts to distribute the working force over the field 
of industry wherever it is most needed. The remarkable 
(though far from perfect) adjustment of industry to the needs 
of each neighborhood is brought about by individual motives, 
not by centralized authority. Wherever consumers settle, 
stores are started and factories are built. Wherever work is to 
be done, men come in about the right number to do it. It is 
not mere chance that produces this result. The available skill 
is adjusted to varying needs by the delicate measurement of 
the market rate of wages. Two-sided competition gives a 
definite rule of price — the only definite impersonal rule. The 
theoretical competitive price is the standard to which things 
tend constantly to adjust themselves in an open market.^ 

Competition is an essentially economic method as contrasted 
with the legal and personal methods above and later described, 
because it is impersonal and reducible to a rule of value. Dis- 
tribution under competition is made, not with reference to ab- 
stract ethical principles or to personal affection, but to the 
value of the product. Each worker strives to do what will 
bring him the largest return, and the price others pay ex- 
presses their estimates of the service in that market. Each 
seeking his own interest is led to make himself more valuable 
to others. In most cases and in large measure, competition 
stimulates men to sacrifice, to invention, to preparation; thus 
is zeal animated and are efforts sustained. In the economic 
realm, as is now seen to be the case in the biologic realm, eom- 

6 See ch. 13, § 9 and § 10. 
TSee ch. 32, § 10. 

8 See Vol. I, pp. 54 and 66; also pp. 504-507 on an organic theory of 
value. 



Cir. 34] METHODS OF DISTRIBUTION 581 

petition of some effective kind is an indispensable condition 
not only of progress but of life without degeneration. Mo- 
nopoly, as we have noted, never lias ceased to rest under the 
ban of Anglo-Saxon law, and therefore to exemplify compul- 
sory as opposed to competitive distribution. A striking fea- 
ture of the competitive method is its decentralization. Each 
helps to value the economic services of each. If one pays 
more for the services of the singer than for those of the cook, 
it is not because one would rather listen to the singing than to 
eat when starving, but because by apportioning one's income 
one can get the singing and the eating too. In the existing 
circumstances, the singer's services seem to the music lover to 
be worth paying for, and he backs his opinion with his money. 
So each is measuring the services of all others, and all are 
valuing the services of each. It is distribution by valuation, 
and it is valuation by democracy, with all of the defects of 
the frail and foolish human beings who are expressing their 
choices. 

§ 8. Wide acceptance of competition. On purely abstract 
and a priori grounds competition cannot be accorded an un- 
qualified ethical sanction, a.s is sometimes assumed. It is not 
always and necessarily "right" and "best" in an absolute 
sense. Plowever, "its dominant place is not a mere accident, 
but is a resultant of unending experimentation with different 
methods of distribution carried on since the beginning of 
human society. A method of distribution had to be found 
and retained that would work under the conditions of human 
nature at each stage of social progress; and competition has 
worked, however imperfectly, because it has met in large 
measure the pragmatic test. The competitive rule of dis- 
tribution appeals to all men (even to those who denounce it) 
as having in many of its applications a moral cliaracter, as 
compared with the other possible methods of distribution. 
Indeed, the competitive rule is' the only rule that does not 
involve either personal and arbitrary judgment (force, char- 
ity, and authority) or status. Even such a measure of justifi- 



582 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

cation as is found in status is traceable, in the long run, to 
competition. The case for a limited application of status (as 
in property and inheritance laws) is based upon its results in 
stimulating motives of effort and accumulation.'' Wlien the 
rule of authority is applied to-day in the large field of public 
regulation where actual competition has become impossible, 
almost the only guiding rule is hypothetical competition. The 
just rate is felt to be that which in the long run would he 
just sufficient to afford "normal" incomes to labor and to 
capital, to call forth the necessary effort, skill, judgment, fore- 
thought, abstinence, and investment, if competition were at 
work, as it is not.^° Only this rule of hypothetical compe- 
tition redeems these public rates from arbitrariness, favori- 
tism, and force. 

§9. "Economic harmonies" and discords. Every truth 
in political philosophy finds some exaggerated expression. 
Competition, as compared with status and custom, has some 
notable merits; and when the eighteenth century was throw- 
ing off some of the burdens inherited from the more static 
Middle Ages, competition appeared to be a panacea for all the 
ills of society.^^ The belief in the benefits of competition and 
the virtues of economic freedom found its extremist expres- 
sion in the first half of the nineteenth century in the doctrine 
of the "economic harmonies." According to this, if men are 
left entirely free to do as their interests dictate, the highest 
efficiency and best results for all will follow; the economic 
interests of all men are in harmony. Corresponding with this 
doctrine is the economic 'policy of extreme laissez faire. 

But experience has shown that the ecouomJc interests of the 
individuals in a community are only partly, very rarely are 
they wholly, in harmony. There are three planes of compe- 
tition in every market : that between sellers, that between buy- 
ers, and that between sellers on the one hand and buyers on the 

9 See above, § 2, note 3. 

10 Compare, e.g., portions of chs. 9, 14, 21, 22, 28; and 31, § 16. 

11 See ch. 32, §§ 11-13. 



Ch. 34] METHODS OF DLSTRIBUTION 583 

otlier.^- If at any point free competition is hindered, even 
the disciple of economic harmony must, from the very nature 
of his doctrine, expect a discordant result. In realitj', competi- 
tion is rarely quite complete on both sides, and when it is not 
the weak usually suffer. Men do not start with fair oppor- 
tunities. All that they may be entitled to have under com- 
petition m?Ly be so little that social sympathy seeks to better 
the results ; hence poor relief, public and private. Society as 
a whole has an interest in the outcome of the individual 's eco- 
nomic struggle. It cannot see men starving or driven into 
crime. Moreover, when competition is the rule of valuation, 
it, like all valuations, partakes of the quality of those choosing 
— wise or foolish, good or evil.^^ And though competition is 
the rule of democracy in economics, yet democracy cannot per- 
mit the economic vote of a vicious or of a foolish group to 
stand, where the goods, services, and prices resulting offend 
the prevailing public judgment and social conscience. 

§ 10. Competition modified by charitable distribution. 
In practice the competitive method of distribution always 
has been modified or supplemented in varying degrees by the 
other methods. Important among these is charitable distribu- 
tion. Charitable is here used in its original sense, as synony- 
mous with benevolence and affection. First is parental love, 
the root and type of all the forms of charity. There is a 
complete lack of economic equivalence in the relation of par- 
ent and child in early years. The helpless infant does noth- 
ing for the parent, the parent gives all and does all for the 
child. Gradually, however, the balance is regained; as the 
years go on, not only do children repay in aft'ection, but in 
many cases they repay in material ways. Especially in the 
factor}^ districts and on the farm, the child sooner or later 
begins to reestablish the balance, becomes a worker, and con- 
tributes to the family income as much as the cost of his sup- 
port, and finally more. A student of modern English town 

12 See Vol. I, p. 75. 

13 See, e.g., Vol. I, pp. 25, 71, 205, 479, 509, 511, 513. 



584 PRIVATE PROPERTY VS. SOCIALISM [Pt. VT 

life has traced the curve of poverty traversed by the average 
poor family as the children are first an economic burden and 
later an aid to their parents. In the middle, or propertied, 
classes the children do not for many years cease to be a finan- 
cial burden to their parents, and in most cases the economic 
balance is never reestablished. It is not to the parents, but 
to the succeeding generation, that the debt is tardily paid. 

Friendship widens the range of generosity and multiplies 
the mass of gifts. Broad sentiments of humanity lead to 
gifts outside the range of personal affection and personal in- 
terest, to the beggar on the street, to institutions devoted to 
charity. In New York state alone a sum of more than $20,- 
000,000 a year is expended by institutional charities. About 
$512,000,000 in public benefactions were given in the United 
States by private donors in the year 1915, and in this re- 
spect that year was not exceptional. An enormous and in- 
creasing body of property is thus being year by year socialized, 
largely through bequests from persons without direct heirs. 
Great public subscriptions to the sufferers from unusual dis- 
asters, such as the Irish and the Indian famines, the Chicago 
fire, the Galveston flood, the San Francisco earthquake, the 
great European war, bespeak a widening generosity. Re- 
ligion impels to the building of churches, to the support of 
priests, missions, and manifold religious undertakings. 
Charity in this connection is the expression of a sentiment that 
varies from the most intense personal affection to the broadest 
and most general humanitarian sentiment. 

§ 11. Competition modified by authoritative distribution. 
Authority is essentially the assignment of a common, or social, 
income to individuals by some person or persons chosen, or 
accepted, by the society to perform this function. After 
force, it is the oldest and was the earliest widely operative 
method of distribution. It shades into force, status, and 
charity in manifold ways. But it may be distinguished from 
force, which takes for itself what belongs to another ; and from 
charity, which gives to another what belongs to one 's self ; and 



Ch. 34] METHODS OF DISTRIBUTION 585 

from status, which transmits claims to income from one gen- 
eration to another by a fixed impersonal rule, not by a per- 
sonal judgment in the particular case. 

Authoritative distribution is the dominant method in patri- 
archal tribes, in communal societies, and in monastic and other 
religious orders. Each person works at what he is com- 
manded to do, and some one in authority (patriarch, head of 
tlie community, father of the monastic order) portions out the 
tasks and the rewards. In the family this rule largely pre- 
vails, and even after the children have come to years of dis- 
cretion they not infrequently accept, from habit or affection, 
the will of the parents, and give up their entire wages to re- 
ceive back a portion. The method of charitable distribution 
while the child is young gradually changes to authoritative 
distribution after the child becomes a worker. The untrained 
and indocile youth, however, is made the subject of com- 
pulsory distribution. 

The collection and distribution of taxes is by public au- 
thority. No attempt is made to give back an exact equivalent 
to each taxpayer. The money is taken and spent by authority. 
The new forms, or at least the new extensions, of taxation, es- 
pecially of incomes and inheritances at progressive rates, are 
very important examples of authoritative distribution. The 
courts sometimes find themselves obliged to apply the method 
of authoritative distribution, although they do it unwillingly. 
They try to confine their efforts to interpreting the contracts 
men have voluntarily entered into, and they avoid, as far as 
possible, the making of contracts or the fixing of rates. 
Authoritative distribution is exemplified in the work of many 
commissions appointed by law to fix rates or settle disputes, 
such as boards of conciliation and arbitration and railway com- 
missions. 

§ 12. Progressive versus reactionary. Distribution in 
the present economic system, in all its modifications in the 
various industrial states of the world, thus is revealed by our 
examination to be determined, not by a single principle, but 



586 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

by au eclectic grouping of various principles and methods. It 
is further revealed not as final truth fixed in its details, not 
as an absolute expression of human wisdom, but as a constantly 
changing result of human experience. The world of free 
parliamentary governments is a vast laboratory of experi- 
mentation wherein the institutions of property and the 
process of distribution are being shaped by the forces of 
public opinion. Changes are constantly embodied in legis- 
lation, in judicial interpretation, and in the administration of 
the laws.^* 

The different individuals and groups in our society take 
various attitudes in respect to our present economic system 
and to the views just expressed. Indeed, opinions are in- 
numerable and grade off with manifold differences of degree 
and in detail from one extreme to the other. However, all 
opinions on this subject may be classified broadly in two 
groups — conservative and destructive (or disruptive) ; the 
one favoring the present economic system in its essentials, the 
other rejecting the essentials of the present system. Each 
of these broad gi^oups may again be subdivided: the con- 
servatives having two wings, the stand-pat conservatives (the 
extreme being the reactionaries) and the other the progressive 
conservatives. (It need hardly be said that progressive is 
not used here with reference to any political party or group 
that has been designated by that name.) The reactionary 
conservatives are numerically a small group, but in wealth, 
social position, and political influence are very powerful. 
They favor the existing order, excepting in those features 
designed to limit wealth and the use of monopolistic power. 
The stand-pat conservatives are a much larger group of 
moderately well-to-do, including most of the residents on 
''Main Street," who like things just as they are. 

§ 13. Progressive versus radical. The conception of the 
present economic system outlined above may likewise be called 

14 Almost every chapter of this volume gives examples of these state- 
ments; but recall especially chs. 17, 22, 23, 29, 31, 33. 



Ch. 34] JNIETHODS OF DISTRIBUTION 587 

conservative, but it must be moclitiecl b}^ the adjective pro- 
gressive, or liberal, as contrasted with reactionary. In this 
view the central features of the present economic system 
must continue much as they are, and progress must be won 
by gradual correction of evils. These are recognized to be 
many, and to call constantly for remedial legislation and 
remedial effort in our rapidly shifting industrial conditions. 
The progressive-conservatives believe that the evils are not 
due solely or mainly to the "i^resent economic system"; 
they believe that a workable economic system cannot be de- 
vised by doctrinaire philosophers as a thing apart from hu- 
man nature, a thing to be declared absolutely good or bad 
without reference to the kind of people who compose the com- 
munity. The present economic system can be made better 
only slowly and as the individuals who compose the com- 
munity keep pace with growth in virtue and wisdom. There- 
fore, the progressive-conservative sees that much of the task 
of social progress is individual and family education, moral- 
izing the oncoming generations with the old-fashioned virtues 
of thrift, honesty, loyalty, and duty. All such suggestions 
are impatiently and angrily rejected by the more radi- 
cal social reformers, who (again with varying emphasis and 
with many gradations of opinion) advocate abandoning the 
present economic system and substituting for competition with 
private property a universal principle of authority. 

References. 

Hinds, W. A., American communities, 2d ed. Chicago. Kerr. 1908. 

(Describes many experiments, all failures; bj' a sympathizer with 

socialism. ) 
Locktoood, (?. B., The New Harmony movement. 2d ed. N. Y. Ap- 

pleton. 1907. 
Nordhoff, C, Communistic societies of the U. S. N. Y. Harper. 

1875. 



CHAPTER 35 



SOCIALISM, PRESENT AND FUTURE 



§ 1. Meanings of socialism. §, 2. PMlosopMc socialism. §, 3. So- 
cialism in action. § 4. Origin of the radical socialist party. § 5. 
The two pillars of "scientific" socialism. § 6, Aspects of the material- 
istic philosophy of history. § 7. Utopian nature of "scientific" so- 
cialism. § 8. Its unreal and negative character. § 9. Revisionism in 
the Marxian ranks. § 10. Socialism and anarchism. § 11. Syndi- 
calism and I. W. W. § 12. Guild socialism. § 13. Opportunism in 
socialist party tactics. § 14. Alluring claims of party socialism. § 15. 
Changes in the socialist party vote. § 16. Economic legislation and the 
political parties. 

§ 1. Meanings of socialism. Our reason for leaving to 
the last the discussion of autliority as a method of distribu- 
tion is not that it appeared last in historical development, 
but that it now is the most strongly advocated as an alterna- 
tive of competition. In primitive, in ancient and in medie- 
val societies, authority as a method of distribution was used 
much more than it now is, and the history of Europe from 
about the eleventh century is filled with the record of the 
displacement of authority and status by competition. But 
one of the most striking developments of opinion in the nine- 
teenth century was that favoring an increasing use of author- 
ity in distribution. Authority has been advocated not merely 
to supplement and modify competition, but to displace it com- 
pletely or, in the more moderate program, in large part. 

This opinion, or plan, has appeared under a variety of 
names, the main ones being communism, collectivism, social- 
democracy, and socialism, of which the last name has just 
now the greatest vogue. Socialism is a word of manifold 

588 ■ 



Cii. 35] SOCIALISM PRESENT AND FUTURE 589 

meanings no one of which is g:enerally accepted. Discussion 
is therefore often a Babel of tongues. JIuch of the confusion 
may be cleared up by observing that the word "socialism" 
designates (1) a social^ philosophy (2) a mode of social 
action, (3) a particular political party. There is thus philo- 
sophic, active, and partizan socialism. Each of these may 
be taken either in an absolute or in a more or less relative 
sense. The first meaning is the most fundamental, the 
second less so, and the last the least fundamental, but just 
now the most frequently used. 

§ 2. Philosophic socialism. As a philosophy socialism is 
related to social just as individualism is related to individual. 
Socialism is faith in the group motive and group action rather 
than in self-interest and competitive action. Instead of social 
philosophy we may say social faith, or social ideals. This 
faith may be absolute, or radical, to the rejection of all eco- 
nomic competition; or it may be moderate, and leave more 
or less place for self-interest and competition. Every 
man of conscience and of ideals has moods that are social- 
istic (in this sense) and dreams of a world without toil, com- 
petition, or poverty. 

This social philosophy has taken form as ' ' Christian Social- 
ism" among men of strong religious natures, in various re- 
ligious denominations. Great secular dreamers — Plato in his 
"Republic," Sir Thomas Moore, in his "Utopia," Edward 
Bellamy, in "Looking Backward," William Morris, in "News 
from Nowhere," and others — have painted beautiful pictures 
of ideal economic states from which all of the great evils and 
problems of our society have been banished, 

§ 3, Socialism in action. Active socialism is group action 
in economic affairs. This may be by private voluntary 
groups, as a club, church, or trade union, or by a public group, 
or political unit of government, which has therefore a com- 
pulsory character. The most radical kind of active socialism 
would be the ownership by government of all the means of 

1 See Vol. I, p. 6, on "social" and the social sciences. 



590 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

production and the conduct of all business, assigning men, 
by authority, to particular work and granting them such in- 
comes as the established authority thought they deserved. 
This kind exists nowhere, and never has existed, though it has 
been nearly approached in many parts of Russia under the 
Bolshevik regime. 

A moderate kind of active .socialism is represented by 
each separate case of public ownership or industry. Even 
public regulation by authority, of the many kinds de- 
scribed in this volume, is touched with a quality of active 
socialism. In this sense there can be more or less of active 
socialism in a community; a state may be more or less social- 
ized in its economic aspects. An English Chancellor of the 
Exchequer declared in the last decade of the nineteenth cen- 
tury, "We are all socialists now." The ever-increasing 
sphere of the state ^ gives to that statement to-day a larger, 
fuller meaning than when it was uttered. 

Socialism in action is of course always the expression 
of a more or less socialistic philosophy held either by a 
democratic majority of the people or by a despotic minor- 
ity, as in Russia under the Czars and the Bolsheviki. 
Most of the great recent movement of socialism in indus- 
try is the expression not of a radical but of a moderate 
social philosophy. It does not look to the abolition, but only 
to the modification and limitation in some directions, of pri- 
vate property and of competitive industry. The spirit of this 
movement is opportunist, or experimental. It is ready to try 
public action, but recognizes that it has difficulties and limita- 
tions. The ultra-radical and the ultra-conservative alike de- 
clare that these measures "logically" lead on to the com- 
plete destruction of private property. But men find that they 
can warm their hands without being "logically" compelled to 
thrust them into the fire, and that they can quench their thirst 
without a growing resolution to drink the well dry. When 

2 See e.g., eh. 9, §§ 2, 10; ch. 11, §§ 7, 8; cli. 7, §§ 3, 4, 12; chs. 
19, 22, 23, 24, 29, and 31. 



Cii. 35] SOCIALISM PRESENT AND FUTURE 591 

this governmental activity has proceeded somewhat exten- 
sively and systematically in cities, as in Great Britain, it is 
called municipal socialism; and in states, as in Germany be- 
fore the World War, it is called state socialism. 

§ 4. Origin of the radical socialist party. Socialism in 
the partizan sense is an actual political organization. Both in 
Europe and in America such organizations have been desig- 
nated as "social-democratic," "socialist labor," or "labor'" 
parties. Socialism in this sense of a party organization, or 
movement, is very different from a social philosophy. In its 
partizan phase socialism exhibits all of the baffling variability 
and elusiveness that it does in its other aspects. However, in 
its printed program, the socialist party sets forth both a social- 
ist philosophy and an ideal of active socialism in their most 
radical forms. 

Modern political socialism traces its origin directly to the 
most radical of German social philosophers, Marx, Engels, and 
Lassalle. Karl Marx (1818-1883), preeminently the philo- 
sophic leader of the movement, collaborating with his friend 
Friedrich Engles (1820-1895), sought to give a solider founda- 
tion of reason to the somewhat romantic socialist philosophy 
current in his day. His own doctrine, first set forth con- 
nectedly ^ in the Communist IManif esto in 1847, and later 
developed in his chief book "Das Capital," he called Com- 
munism. He deemed this to be, as it has been called by his 
followers, "scientific socialism." "Scientific" was meant to 
emphasize the contrast with "Utopian" socialism, as Marx 
and Engels somewhat scornfully characterized alike the older 
communist philosophy, the romances of the ideal state, and 
the attempts to found and conduct small communistic societies. 

§ 5. The two pillars of "scientific" socialism. Scientific 
communism was to be based upon two immovable pillars, the 
one economic, the other historical (or historico-philosophical). 
The one was the labor theory of value, by which Marx sought 

3 See Vol. I, p. 502, on communism and value theory. 



592 PRIVATE PKOPEETY VS. SOCIALISM [Pt. VI 

to show that all profits and incomes from investment were due 
virtually to robbery of the wage-workers.* "Capital," that 
is, the ownership of the means of production, was declared to 
be the instrument of this ''exploitation." 

The other pillar was ''the materialistic philosophy of his- 
tory," that is, the explanation of all the intellectual, cultural, 
and political changes of mankind from the side of the material 
economic conditions as causes. As Engels expressed it, "The 
pervading thought . . . that the economic production with 
the social organization of each historical epoch necessarily 
resulting therefrom forms the basis of the political and intel- 
lectual history of this epoch." This doctrine denies that, in 
an equally valid sense, biological changes in brain, and 
cultural changes in science, arts, and education, cause the 
mechanical inventions and improved processes and thus alter 
the form of economic production. 

§ 6. Aspects of the materialistic philosophy of history. 
Marx's general philosophy of economic materialism had three 
minor propositions or doctrines, (a) The doctrine of increas- 
ing misery; capital in private hands results in the "exploita- 
tion" of the workers as explained by the economic theory of 
surplus value (labor theory of value) ; this causes and must 
cause the steadily increasing degradation of the masses, (b) 
The doctrine of the class conflict; all history is a record of the 
class struggle between those who have property, the ruling 
classes within the nations, and those who have not, the op- 
pressed working class, (a conception of history blind to most 
of the great international conflicts). The class conflict was 
declared to be growing more sharply marked and bitter than 
ever before ; ' ' the entire human society more and more divides 
itself into two great hostile camps, into two great conflicting 
classes, bourgeoisie and proletariate." (c) The catastrophic 
theory; the final and inevitable result of this misery and class 
confiict must be a revolution, when the downtrodden workers 

4 See Vol. I, pp. 210, 228, 502 on the labor -theory of value. 



Ch. 35] SOCIALISM PRESENT AND FUTURE 693 

will throw off their chains and "expropriate the expropria- 
tors/' and institute the communistic order in place of cap- 
italism. 

§7. Utopian nature of "scientific" socialism. The terra 
"scientific" set in contrast with " Utopian" was meant to im- 
ply that the doctrine of Marx was not " Utopian" (a word 
that had come to mean fanciful and impracticable). Marx 
had a contempt for the romances of the ideal state and for 
what he deemed to be the unfounded speculations of earlier 
prophets of communism. But Utopian (from utopia, Greek 
for no place) means nonexistent, and Marxian socialism surely 
was that. The words "experimental" or "actually at work" 
would have been a more logical contrast with " Utopian" than 
is the word "scientific." Marx and his followers likewise 
had a contempt for the communistic experiments, or settle- 
ments and colonies, which by the scores had been started 
and had failed, bringing discredit upon all communistic pro- 
posals. The beauty of "scientific" socialism for the purpose 
of discussion was that it never could be tried on a small 
scale, or tried at all until a whole nation adopted it; there- 
fore, its adherents believed that no facts of history or of 
human nature could be used to disprove its workableness. 

The old time * ' scientific ' ' socialist had a lofty scorn for any 
less dogmatic philosophy than his owti or for any less sweep- 
ing social change than that he expected. Moderate social re- 
form to him was but temporizing ; indeed, it was evil, inasmuch 
as it helped to postpone the inevitable, but in the end, benefi- 
cent catastrophe of the social revolution. A step-by-step 
movement toward socialism, state socialism,^ even of a pretty 
sweeping character, was, to the old-time Marxians, not really 
socialism at all. Some explanation of this attitude is found in 
the extremely limited manhood suffrage and in the aristocratic 
class government of most European countries, especially of 
Germany; so that, as the party socialists saw it, multiplying 
state enterprises but increased the power of the ruling, and 

5 See above, § 3. 



594 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

eventually of the militarist, class. The social-democratic 
leaders felt that until they themselves were in power, the 
grovrth of "state socialism" would be a calamity for the na- 
tion. The events of 1914 may make our judgment tolerant 
toward their feeling. 

§ 8. Its unreal and negative character. The so-called 
''scientific" socialism had, therefore, a peculiarly unscientific 
spirit ; for, in a modem sense, science implies a patient search 
for truth, not a sudden revelation ; a constant testing of opin- 
ions by observation and experiment, not a dogmatic conviction 
that refuses the test of reality. "Scientific" socialists talked 
much, and still talk much, of the "evolution" of social insti- 
tutions; but they refused to admit the essential condition for 
institutional evolution, the competitive trial on a small scale, 
of a new form of economic organization to prove its fitness to 
survive. Indeed, communism had been tried on a small scale 
many times in the communistic societies, and had always 
failed in a brief time. 

Lincoln said that a man's legs ought to be long enough to 
reach to the ground; but "scientific" socialism was not built 
on that plan. To be sure it contained many elements of truth, 
but these were so distorted that the result was a caricature of 
history, of philosophy, of economics, and of prophecy. The 
most important influence of radical socialism has been exerted 
through negative criticism. It has performed the function of a 
party in opposition, relentlessly hunting out and pointing out 
the defects of existing institutions, arousing the smugly con- 
tented, and, by its very recklessness and bitterness, inspiring 
at times a wholesome fear of more revolutionary evils. This 
has been a real service to the cause of moderate and con- 
structive reform in the more democratic countries of west- 
ern Europe and in America. 

§9. Revisionism in the Marxian ranks. "Marxism" or 
Marxian "scientific" socialism, from the time of its promulga- 
tion was studied by a small but increasing group of disciples 
as a well-nigh inspired and perfect revelation of economic 



Cii. 35] SOCIAIJSM PRESENT AND FUTURE 505 

truth. Das Kap'Ual became known as the communist bible; 
zealous followers held it to be their duty to accept it, even 
where thej' could not understand it or reconcile it with the 
realities around them. The various doctrines composing the 
Marxian system were expressed in phrases ambiguous enough 
to permit much loose and shifting thought. But vigorous 
criticism forced vipon the attention of the more frank and 
intellectual radicals, the need of more accurate and greatly 
modified conclusions. The labor theory of value which Marx 
had taken from English Ricardian economics was discredited 
by the critique of the psychological economists of Austria 
and America. The doctrine of increasing misery which first 
was taken to mean what is said, came to be explained not in 
an absolute sense, but in a relative sense (that the masses 
may be getting more wages, real as well as monetary, but 
they are not getting as much more as are the owners of cap- 
ital). The doctrine of class conflict, it was admitted, had to 
be softened greatly to fit the facts of modern society. Doubt 
as to the inevitableness of the great catastrophe grew stead- 
ily. It cannot be questioned that jMarx, when he first 
formulated his philosophy, believed that a revolution, most 
violent in nature, would occur within a few years. The 
revolutions of 1848 came, but with no such results as Marx 
predicted. Thereafter radical socialists played fast and loose 
with the word "revolution." They made it mean a violent 
and bloody civil war with victory for the warlike minority, 
whenever they wished to rouse a proletarian audience. But 
in addressing bourgeois hearers they made revolution mean 
a slow evolution ending in peaceful victory at the polls by 
a majority of the nation, after many years of educational 
propaganda and of further industrial changes. 

As socialist intellectual leaders began to be affected by the 
criticism originating outside of the ranks they lost some of 
their theoretical illusions, and began to temper their claims of 
Marx's infallibility. " Revisioriism, " the socialist higher 
criticism, beginning in 1899 with the work of Eduard Bern- 



596 PRIVATE PEOPERTY VS. SOCIALISM [Pt. VI 

stein, a prominent German Social-democrat, gained influence 
in the party counsels in all countries in the years before 1914, 
This brought many of the Marxians much nearer to the more 
opportunist ideas and plans of the Fabian society, which had 
been founded in England in 1884, but which had been re- 
garded scornfully by the adherents of "scientific socialism." 
§ 10. Socialism and anarchism. In these and other re- 
spects the socialist movement, while gaining in the total num- 
ber of its adherents, was breaking up into various schools 
of thought. Ceaseless and often bitter controversy over 
matters of doctrine and of policy have divided the leaders 
and split the parties. Almost the only general agreement 
among them is on a negative point, hostility to the existing 
system of private capital. In respect to the forms of politi- 
cal and of industrial organization that are to take the place 
of the present order, communist ideas and plans differ widely. 
In the last quarter of the nineteenth century Marxian social- 
ists were usually associated in popular thought with the 
bomb-throwing type of anarchists whose aim was to destroy 
all government and whose policy was that of terrorism and 
assassination of members of the ruling class. Usually the 
''scientific" socialists scornfully denounced this classifica- 
tion, declaring that socialism trusted to peaceful evolution, 
not to violence, that socialism put its hope in the triumph of 
democratic majorities, whereas anarchy hoped to win its ends 
through the violence of a minority. Socialism, they said, 
was primarily concerned with economic organization, and so 
far as it was concerned with government, looked toward a 
completer organization pf the state for social purposes, 
whereas anarchy was essentially opposed to the state in any 
form. In truth, as we have observed above, some socialists 
conceived of class conflict as gradual evolution, while others 
conceived of it as bloody and not distant revolution. The 
rank and file of the socialists have been ready as a majority 
to ''expropriate the expropriators" peacefully, if they could, 
and willing as a minority to do it violently if they must. 



Ch. 35] SOCIALISM PRESENT AND FUTURE 597 

§ 11. Syndicalism and I. W. W. Among the various ten- 
dencies, or schools, witliin socialistic circles, two especially, 
syndicalism and guild socialism, have sho^vn the marks of 
anarchistic influence. These both share the anarchistic dis- 
like of strong central government, and cherish the ideal 
of self-governing independent communes. The model of the 
early anarchists was the simple Russian village community. 
Syndicalism in France originallj^ meant trade unionism. The 
French syndicates (trade unions) which developed many 
years later than did the British unions, came under the in- 
fluence both of Marxian socialism and of anarchism in the 
'80 's and '90 's, and developed a hybrid form of theory and 
of program. Syndicalism is anti-parliamentary and opposed 
to political action within the present capitalist states. It 
opposes militarism, and repudiates patriotism for any coun- 
try. It favors the violent revolt of a minority whenever the 
workers are well organized enough to seize power. It 
favors the general strike as a means of wrecking society, 
not merely to win in immediate wage-controversies. Its 
most characteristic doctrine, detestable to all outside its 
ranks, is sabotage, which means any kind of vandalism, deceit 
and dishonesty which may inflict loss upon employers and 
capitalists and inspire their fears. Everything is permis- 
sible and laudable which would be done by a spy in modern 
war, for the syndicalist declares that a state of war exists. 
Yet he does not draw the corollary that every one with 
such a purpose and using such means should expect to be 
shot as an enemy spy. The syndicalist's economic ideal of 
the future state is somewhat vague, but it is one of commun- 
ism, in which the instruments of production in each trade 
would be controlled by the unionized workers. After a rev- 
olution attained by sabotage and bloodshed, men would dwell 
together peacefully without restraint of any government, 
ruled only by sweet reasonableness. 

Syndicalism has been most influential in France and Italy 



598 PEIVATE PEOPERTY VS. SOCIALISM [Pt. VI 

among the less skilled workers, but in Europe appears to have 
lost of late somewhat both in its intellectual and in its popu- 
lar following. In America it appears as the I. W. "W. (Inter- 
national Workers of the World) in some cities, but chiefly 
among the migratory workers in mines, lumber camps, and 
agriculture in the Middle and Far West. 

§ 12. Guild Socialism. A school of writers, known as 
Guild Socialists, which has attracted wide attention since the 
war, had its origin in England about 1907, and in 1915 
founded the National Guilds League. Guild socialism re- 
sembles syndicalism (and philosophic anarchy) in its plan 
of the future state. Producers are to be organized in shops, 
or in groups, which are to be further federated in a national 
guild, the supreme council of producers. This plan suggests 
more of a unified state than does syndicalism, a sort of ' ' dual 
sovereignty" of local producing guilds and central social 
organization. These ideas seem to be all in the realm of 
imagination (Utopian) but they were reflected somewhat in 
the widespread discussion after the war for ' ' industrial democ- 
racy" as in the Plumb Plan for the ownership of railroads 
by the railroad workers. Unless and until groups of trade 
workers can demonstrate by experiment, at their own risk, 
that they can cooperatively carry on enterprises of some size 
with success, the rest of the nation, the great body of con- 
sumers, must look upon such proposals as unpractical. The 
Bolsheviki since the second revolution in Russia in 1917, have 
exemplified the sjmdicalist ideal of a ruling militant minority, 
and in the Soviets, or local governing bodies made up of 
organized workers, have shown some likeness to the guild ideal. 

§ 13. "Opportunism" in socialist party tactics. While 
many winds of doctrine have been blowing over socialistic 
philosophy, the practical programs of the party have veered 
in various directions. Whenever the party gained any 
success at the polls, the socialists in public office and the 
party leaders found it necessary to "do something" imme- 
diately. The rank and file might be willing to talk of the mil- 



Cir. .55] SOCIALISM PKESEAT AND FUTURE 599 

lennium, but preferred to take it in instalments instead of 
waiting for it to come some centuries after they were dead. 
And so the socialist party, as fast as it gained any practical 
power, became "opportunist" and worked for moderate prac- 
tical reforms. The leaders did this with many misgivings 
lest the masses might become so reconciled to the present order 
that they would refuse to rise in revolt. In that case the 
revolution never could happen (although it was inevitable). 

As the party socialists did more to improve the present, they 
talked less of the distant future state. They ceased their criti- 
cisms of "mere temporizing" "bourgeois" reforms, and be- 
gan to claim these as the achievements of the socialist party. 
They began to write of the remarkable growth of social legisla- 
tion in Europe and America in the past half century under 
such titles as "socialism in practice" and "socialists at work." 
This was despite the fact that these reforms were all brought 
about by governments in which the socialist party had no part 
whatever or was a well-nigh insignificant minority. This bald 
sophistry, or self-deception, was easily possible by confusing 
the word "socialist" as relating to the abstract principle of 
social action, with socialist as applied to their own party or- 
ganization. It is as if the Republican party in the United 
States were to claim as its own all the works of the republican 
spirit and principles of government in the world from the 
party's organization to the present time. 

The German democratic revolution of November 1918, 
which drove the Kaiser into exile, brought the social-demo- 
crats into power as the dominant party in Germany. The 
more moderate element is in the majority and, in alliance in 
parliament with various liberal parties, has thus far been 
administering the affairs of the state along economic lines 
little different from those of the old order. No serious modi- 
fication of private property has been made. The situation 
is far from clear as yet. We seem to see here again the 
sobering effect of responsibility, and the definite unwilling- 
ness of the German workingmen, with the example of Bol- 



600 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

shevik ruin under their eyes at the East, to risk abolishing 
capitalism. 

§ 14. Alluring- claims of party socialism. In becoming 
opportunist, the radical socialist party in every country has 
been somewhat put to it to retain any clear distinction be- 
tween itself and other parties of social reform. It has done 
this however by continuing to proclaim the ultimate desir- 
ability of re-organizing all society without leaving any pro- 
ductive wealth in private hands; while in practice it has 
shown misgivings prompted by the experience of the world. 
Its ease against the present order continues to be far the 
strongest in its negative aspect, the exposure of evils. To 
many natures the claims of the socialist party have all the 
allurements of patent medicine advertisements. These de- 
scribe the symptoms so exactly and promise so positively to 
cure the disease, that they are irresistible, especially when 
the regular physicians keep insisting that the only way to 
get well is to adopt such troublesome and disagreeable methods 
as taking baths and exercise, and stopping the use of whiskey 
and tobacco. 

Those attracted to the socialist party by its sweeping claims 
are of two main types. The one is the low-paid industrial 
wage-worker to whom competition awards so small a share 
of the national income; the other is the sympathetic person 
of education or of wealth (or of both), who has become sud- 
denly aroused to the misery in our industrial order. To 
both of these types, feeling intensely on the subject, the 
socialist party appeals as the only one with promises sweep- 
ing enough to be attractive. The one becomes the proletarian, 
workshop socialist, the other the intellectual, parlor socialist. 
Many of the latter type are persons overburdened either 
with unearned wealth or with an undigested education. Many 
of them, having enjoyed for a time the interesting experi- 
ence of radical thought and of bohemianism, come later to 
more moderate social opinions. 

§ 15. Changes in the socialist party vote. The socialist 



Cir. 35] SOCIALISM PRESENT AND FUTURE 601 

vote in Europe and in the United States had been steadily- 
growing in the forty years preceding the outbreak of the 
World War, and amounted in the aggi'egate at least to six and 
possibly to ten millions (as variously estimated, the name 
socialist being elastic). There were 3,000,000 social-demo- 
cratic voters in Germany at the outbreak of the war, and the 
socialist party in the United States polled 900,000 votes in 
the presidential election of 1912. The socialist parties were 
made up of men of many shades of opinion. They included 
not only the radicals, but large numbers of the discontented, 
unable to find an alternative economic philosophy and a plan 
that inspired their hopes. They included manj- others who 
held only the mildest sort of socialistic philosophy. In Amer- 
ica many men voted the socialist ticket as a protest against 
the inaction of the conservative parties, and barely one- 
tenth regularly enrolled as members of the party. Similarly, 
in Germany before the war many voters supported the social- 
democratic party merely as the most effective way to protest 
against Militarism, Kaiserism, and undemocratic class gov- 
ernment. 

The war affected profoundly the policies and fortunes of 
partizan socialism. In accord with the doctrine of the class 
conflict, Marx had exclaimed, in the Communist Manifesto, 
"Proletarians of all lands, unite." Marxian socialism con- 
demned national patriotism and fostered in its place a spirit 
of internationalism. For years prominent IMarxians had 
boldly announced that any attempt to bring on a European 
war would be blocked by a general strike declared by the 
socialist workers. But when German militarism precipitated 
war in 1914, only a feeble fraction of the German radical 
socialists stood out against it, and nearly all socialists in every 
country lined up with their fellow nationals. The immediate 
result was loss of prestige and of following for the socialist 
parties in the allied countries. 

The American socialist party with an enrolled membership 
largely of immigrants, many of them still unnaturalized, was 



602 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 

more unpatriotic and pro-German than were the socialists in 
any of the other allied countries. A number of its American 
members and of those born in allied countries left the Amer- 
ican socialist party. The socialist vote for presidential electors 
fell to 590,000 in 1916, but rose again in 1920 to 900,000. 
In addition over a quarter of a million of votes were cast, 
mostly in the Northwest, for the Farmer-labor party, pre- 
senting a state-socialist program. 

§ 16. Economic legislation and the political parties. 
These figures, while indicating no landslide to communism, 
do not forecast the disappearance of the radical socialist 
philosophy and of the socialist party. Both philosophy and 
party are based on the fact of great inequality in the distribu- 
tion of wealth, on the growth of cities and the spread of the 
wage system, on resentment at the abuse of power and at many 
cases of individual injustice suffered by the poor at the hands 
of employers, and on the conviction that conditions cannot be- 
come better under the present regime. The masses now, for 
the first time in history, have the ballot without hereditary, 
class, or property limitations. The world is for the first 
time trying the experiment of full political democracy side 
by side with great private fortunes and great economic in- 
equality. The democratic Samson may be blind, but he has 
the power to pull down the temple of capitalism in ruin upon 
our heads. 

The future of partizan socialism depends on the policy of 
•the other political parties quite as much as it does on its own 
policy. The floating liberal vote with socialistic sympathies 
is now so large that it is eagerly sought by candidates of 
the other parties. These independent voters care little for 
the radical and distant tenets of the socialist party leaders, 
who, to attract wider support, are forced to place in- 
creasing stress upon immediate and moderate reforms. On 
the other hand, men of larger qualities of leadership in the 
older parties are constantly adopting and advancing pend- 
ing measures of social reform. Where this is not done the 



Ch. 35] SOCIALISM PRESENT AND FUTURE G03 

radical socialist party tends more quickly to develop into 
the one powerful party of protest and of popular aspiration, 
receiving support from many elements of the middle and small 
propertied classes and from non-radical wageworkers. This 
movement from both sides is leaving less noticeable the con- 
trast between the socialist party and other parties claiming to 
be ' ' progressive " or " forward looking. ' ' The strongest allies 
of the more radical communistic faction of the socialist party 
are those members of the conservative parties who fail to rec- 
ognize the need of humane legislation, who irritate by their 
unsympathetic utterances, and who unduly postpone by their 
powerful opposition the gradual and healthful unfolding of 
the social spirit, energy, and capacity of the nation. The 
greatest problem of social and economic legislation for the 
next generation is to determine how far, and how, the prin- 
ciple of authority may wisely be substituted for the principle 
of competition in distribution. 

The many and varied forms of economic legislation de- 
scribed in the foregoing pages are so many experiments to 
find that bettCx* and that best adjustment of economic insti- 
tutions to the needs and actual capacities of the people. 
Some of these experiments turn out badly, others well, and 
accordingly some are extended, others after a time are aban- 
doned, perhaps to be tried again by a later hopeful genera- 
tion of men. It does not seem possible for human society to 
stand still or to remain unchanged in respect to the many 
features which go to make up the present order. In some 
ways things grow better, in other ways worse. Moreover, 
this process of change is no longer so unconscious, and human 
society is not now so passive in the hands of fate, as in the 
past. Democratic society has become self-conscious and 
aspires to shape its o\^^l destiny. Can it be wise enough to 
know and will it be virtuous enough to do, that which will 
lead to an ideal social state? In any case it is making the 
attempt which must spell the' continued progress or the 
eventual downfall of human civilization. 



004 PKIVATE PEOPERTY VS. SOCIALISM [Pt. VI 

References. 

Brooks, J. G., The American syndicalism: the I. W. W. N. Y. 

Macmillan. 1913. 
Bussenden, P. F., The I. W. W. A study of American syndicalism. 

Pp. 432. New York. Longmans. 1919. (Historical study of the 

L W. W.) 
Clark, J. B., Social justice witliout socialism. Bost. Houghton. 

1914. 
Ensor, R. G. K., (Ed.), Modern socialism. 2d ed. N. Y. Scrib- 

ner. 1907. (Selections from socialistic sources.) 
Gompers, Samuel, Out of their own mouths; a revelation and an 

indictment of Sovietism. 12nio. New York. Button. 1921. 
Hillquit, M., History of socialism in the United States. N. Y. 

Funk. 1903. 
Hillquit, M., Socialism in theory and practice. N. Y. Macmillan. 

1909. 
Laidler, H. W., Socialisni in thought and action. New York. Mac- 
millan. 1919. 
Eirkup, T., Inquiry into socialism. 3d ed. N. Y. Longmans. 

1907. (A sympathetic, but not a partizan statement.) 
Martin, John, An attempt to define socialism. A. E. Assn. Bui., 4th 

ser. 1 (no. 2) : 347-354. 1911. Round table discussion of above, 

355-367. 
Menffer, A., The right to the whole produce of labor. Trans. 1899. 

(Masterly criticism.) 
Rae, John, Contemporary socialism. 3d ed. N. Y. Scribner. 

1901. (Standard work by a non-socialist.) 
Sohaeffle, A., The quintessence of socialism. N. Y. Scribner. 1898. 

(Exposition by a non-socialist, so favorable that it is used by the 

socialists as a tract.) 
Spargo, John, Socialism. 1906. N. Y. Macmillan. (Pro.) 
Walling, W. W., and associates, The socialism of today. New York. 

Holt. 1916. (A source book of the present position and recent 

development of the Socialist and labor parties in all countries, 

consisting largely of original documents. ) 
Wells, H. G., New worlds for old. N. Y. Macmillan. 1908. (An 

appeal for juster distribution; Fabian school.) 



INDEX 



INDEX 



Accident insurance, 402-406 
Agricultural credit, 126, 470-473 
Agricultural, decay, 446; eco- 
nomics, problems of, 457-475 ; 
prices, fall of, 261 
Agricultural, and rural population, 

441-456 
Agriculture and crises, 150 
Agriculture, exhaustion of the soil, 
260; m(^ieval, 322; number in, 
443; the new, 466 
Aldrich plan, 116 

American Federation of Labor, 341 
Appreciation and interest, 85 
Arbitration, 371-377 
Assessment of taxes, 283 
Authoritative distribution, 583, 
602 

B 

Balance of merchandise, 238 

Balance of trade argument, 255 

Bank, deposits as investments, 
160; restriction act, 101 

Banking, in the U. S., before 1914, 
107-116 

Banks, functions of, 91-106; in U. 
S., 91; taxes on, 299 

Bills of exchange, 98, 241 

Bimetallism, 66 

Bolshevism, 590, 598 

Bonds, as investments, 162; taxa- 
tion of, 292 

Boycott, 347 

Building and loan associations, 
169-174 

Business cycle, 142 

C 

California Fruit Exchange, 468 
Canadian Industrial Disputes Act, 
373, 375 



Canals, 478 

Capitalistic monopoly, 507 

Charitable distribution, 583 

Capitalization theory of crises, 153 

Charity, and control of vice, 383 

Cliild-labor, 362-364 

Christian socialism. 588 

Clayton- Act, 537; and farmers. 445 

Closed shop, see Open shop 

Coal, 569 

Coinage on governmental account, 
44 

Collective bargaining, 343 

Combinations, industrial, 513 

Common law, on monopoly, 524 

Comparative advantages, doctrine 
of, 233 

Compensated gold dollar, 84 

Compensation, for accidents, 403 

Competition among employers, 
339; among workers, 344; and 
monopoly, 522; as regulative 
principle. 535; merits of, 579; 
see also Monopoly 

Competitive system, 552 

Compulsory insurance, 413; econ- 
omy of, 204 

Consolidation, of railroads, 495 

Consumers' League, 367 

Contributory principle in insur- 
ance, 414 

Cooperation, producers', 333-336 ; 
among farmers, 467-470 

Corporation taxation, 298-303 

Corporations, 509-511 

Costs of production, and the tariflf, 
223; 262 

Crises, and industrial depressions, 
138-157; 266; and imemploy- 
ment, 394, 396 

Custom, 553-555 



607 



608 



INDEX 



Debts, public, 275 

Deferred payments, standard of, 
54-69 

Deposits, bank, 94-98 

Dingley Act, 221 

Discrimination, railroad, 484-487; 
see also Monopoly 

Displacement theory of immigra- 
tion, 428 

Distribution of incomes, 574-587 

Doctrine of comparative advan- 
tages, 233 

Dollar, 38, 40 

Dynamic conditions, 148 

E 

Economic, harmonies, 592; prob- 
lems, 3-10; system, the present, 
542-557 

Employment ofJaces, 393 

Engels, Friedrich, 591, 592 

Erdman act, 372 

Eugenics, 419, 433 

F 

Factory conditions, 379-380 

Farm, loans, 472 

Farmers' income, 452; Mutual in- 
surance, 183 

Farming, types of, 460-465 

Farms, area, 457 

Federal Farm Loan Act, 472 

Federal Industrial Commission, 
520 

Federal legislation against mo- 
nopoly, 529 

Federal Reserve Act, 98, 117-137, 
155, 174 

Federal taxation, 295 

Federal Trade Commission Act, 
537 

Fiat money, 51 

Finance, public, 270 

Foreign, banking, 115, 121; trade, 
230; exchange, 242 



Forests, 442, 566-568 

Fractional coins, 39 

Franchises, railroad, 493; for pub- 
lic utilities, 564 

Free trade, 208, 555; see also Pro- 
tective tariff 

G 

Gambling, uneconomic character of, 

177 
General property tax, see Property 
Glass-Owen bill, 117 
Glut theories of crises, 151 
Gold-exchange standard, 47 
Gold, production, 60-64; 79, 80 
Graduation principle, 303, 311 
Greenbacks, 49, 52, 64 
Gresham's law, 41 
Guild socialism, 598 

H 

Health insurance, 409-411 
"High cost of living," 80 
Home market argument, 253 
Housing problem, 384-386 
Hours and wages, public regula- 
tion of, 358-378 



Immigrants, and organized labor, 

339 
Immigration, and low wages, 370; 

and population, 418-437; and 

farming, 465 
Imports into the U. S. chart, 212, 

213, 224 
Income, taxation, by states, 307, 

federal, 308-316 
Independent treasury, 108 
Index numbers, chart, 56 
Industrial revenues of government, 

274; remuneration, methods of, 

321; monopoly, problem of, 505; 

trust, 532; depressions, see 

Crises 
Infant industry argument, 251 



INDEX 



609 



Inheritance, taxes, 304^306; limi- 
tations of, 549 

Insurance, 176-204; companies, 
taxes on, 299; social, 398-416 

Interest rate, and deferred pay- 
ments, 85; and prices, 244; in 
crises, 147 

lutornal revenue, 216, 295 

International exchange, equation 
of, 236 

International trade, 230-245 

Interstate Commerce Act, 496; 
529, 530, 531 

Invalidity pensions, 406 

Investment banking, 162 

I. W. W., 597 



Justice in deferred payments, 81; 
in taxation, 281 

K 

Knights of Labor, 341 
L 

Labor, and legislation, 340; and 
social legislation, 379-397 ; ex- 
changes, see Employment offices 

Laissez-faire, 555, 558, 560 

Land, taxation, 296-298; banks, 
470 

Large production, in public utili- 
ties, 563 

Large industry, 511 

Lassalle, Ferdinand, 591 

Legal tender, 48 

Loans, governmental, 275 

Lump of labor notion, 359 

M 

McKinlejy Act, 219 
Market, public, 561 
]\Iaterialist*c philosophy, 592 
Marx, Karl, 591-596 
Mediation, 371 
Mercantilism, 256 



Merchandise, imports and exports, 
238 

Militarism, and population, 434 

Mill, J. S., 524-550 

ilinimum wage, 368-370 

]\Ionetary economy, 552; system, 
37; theory of crises, 152 

Money, origin and nature, 11-24; 
value of, 41-54; quantity theory, 
25-35; fiduciary, 36-53 

Monopoly, and labor organization, 
350; in railroads, 484-487; in 
protection, 260; industrial, 505- 
521; public policy in respect to, 
522-539; in public utilities, 
562-564 

Mortality table, 192 

Mortgage taxation, 292 

Municipal owTiership, 561 

N 

National ownership, 567 
National Monetary Commission, 

111, 116 
Natural agents, and monopoly, 507 
Negro problem, 419-421 
Newlands act, 372 

O 

Old-age pensions, 406 

Open shop, 350 

Organized labor, 337-357; and 

legislation, 374 
Ownership of farms, 455 



Panic, 139, 142 

Paper money, 48-51 

Par of exchange, 242 

Payne-Aldrioh tariff, 223 

Personal taxes, 304-317 

Picketing, 347 

Piece work, 326 

Police state, 271 

Political, money, 48 ; aspects of 

labor, 352; aspect of railroads, 

487 



610 



INDEX 



Population, agricultural and rural, 
441-456; and immigration, 418- 
437 

Postal savings, 166-168 

Premium plans, 327 

Prices, general level, 54-57; 
market, 535 ; and international 
trade, 244; and monopoly, 519 

Profit sharing, 329-333 

Profits from monopoly, 518 

Progressive taxes, see Graduation 

Property, private, 543-552; taxes 
on, 279, 289-298 

Protection, "true principle" of, 223, 
263 

Protective, tariff, policy of, 246- 
269; tariffs, prevalence of, 208; 
railroad rates, 488 

Public, finance, 270; view of trade 
unions, 353; regulation, of 
hours, 358-378; of railroads, 
492-504; ownership, 558-573 

Public utility commissions, 494 

Public utilities, monopolistic na- 
ture of, 562-564 

Q 

Quantity theory of money, 30-35 
E 

Pace problems, 419 

Eailroad mileage, 480-481; prob- 
lem, 477-489; reg-ulation, 490- 
504 

Eeserve, cities, 110; plan of in- 
surance, 191-204 

Eeserves, bank, 96; against notes, 
124; against deposits, 125 

Eestraint of trade, sCjC Monopoly 

Eevenue tariff, 248 

Eevisionism, 594 

Eural, definition, 443; exodus, 450 

S 

Saturation point of money, 39 
Saving, and investment, 158-175 

6 



Savings, banks: deposits, 102; in- 
surance assets as, 202 
"Scientific" socialism, 591 
Seigniorage, 39, 43 
Sherman Anti-trust law, 448, 449, 

529 
Shifting and incidence,, 252; of in- 

s|urance premiums, 363 
Single tax, 296 
Smith, Adam, 555 
Social, legislation, 379; effects of 

inheritance, 472, 474 
Social insurance, 398-416; by 

trade unions, 340 
Social utility, 22 
Social welfare, in taxation, 272; 

and shorter working day, 367 
Socialism, 588-604 
Standard money, 25, 57; see also 

Deferred paymepts 
State, sphere of, 270; insurance, 

413; ownership, 565 
Status, distribution by, 575 
Strikes, 345, 373 
Syndicalism, 597 



T 



Tabular standard, 83 

Tariff, changes and crises, 149; 
and wages, 257; and unemploy- 
ment, 259; reductions, harm of, 
266; history, American, 207- 
229; rates, 209; for revenue, 
248 ; "true principle" of, 223, 
263; and business depressions, 
264 

Task work, 325 

Taxation, objects and principles' of, 
270-287; revenues from, 278; 
kinds of, 279; separation of, 
295; system of, 316 

Taxes, property and corporation, 
288-303; personal, 304-317 

Tenancy on farms, 458 

Time work, 324 

Trade eiducation, 387 



R D 58 ^ 



INDEX 



Oil 



Trade unions, 337 ; see also Organ- 
ized labor 

Transportation, taxes on, 300; Act 
of 1920, 502. see also Kail- 
roads 

Trust company, 91, 93 

Trust, definition, 512; see Monop- 
oly 

Two-profits argument, 254 



U 



Underwood tariff, 225 
Unemployment, 388-397; in crises, 

142, 146; insurance, 411; and 

tariffs, 259 



Unfair practices, 534 
Usury laws, 382 

W 

Wage contract, limitation of, 381 

Wage-system, 321, 556 

Wages, and tariff, 257; and gen- 
eral prices, 81, 346, 359; and 
organization, 348, 354; and un- 
employment, 391 ; and immigra- 
tion, see Immigration; see also 
Hours and Avages 

Walker tariff, 215, 265 

\^'aterways, 477 

"Wealth of Nations," 555 

Wilson tariff act. 220 

Working day, 358-367 



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